2.	Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Heron Therapeutics, Inc. and its wholly owned subsidiary, Heron Therapeutics, B.V., which was organized in the Netherlands in

March

2015.

Heron Therapeutics, B.V. has no operations and no material assets or liabilities, and there have been no significant transactions related to Heron Therapeutics, B.V. since its inception.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to the financial statements. Our critical accounting policies that involve significant judgment and estimates include revenue recognition, inventory, accrued clinical liabilities, income taxes and stock-based compensation. Actual results could differ materially from those estimates.

Cash,

Cash Equivalents

and Short-Term Investments

Cash and cash equivalents consist of cash and highly liquid investments with original maturities from purchase date of

three

months or less.

Short-term investments consist of securities with maturities from purchase date of greater than

three

months. We have classified our short-term investments as available-for-sale securities in the accompanying consolidated financial statements. Available-for-sale securities are stated at fair market value, with unrealized gains and losses reported in other comprehensive income (loss) and realized gains and losses included in interest income (expense). The cost of securities sold is based on the specific-identification method. Interest and dividends on securities classified as available-for-sale are included in interest income.

Our bank and investment accounts have been placed under control agreements in accordance with our Senior Secured Convertible Notes (the “Convertible Notes”) and Subordinated Secured Promissory Note (the

“Promissory Note”) (see Note

7).

Fair Value of Financial Instruments

Financial instruments, including cash and cash equivalents, receivables, inventory, prepaid expenses, other current assets, accounts payable and accrued expenses, are carried at cost, which is considered to be representative of their respective fair values because of the short-term maturity of these instruments.

Short-term available-for-sale investments are carried at fair value (see Note

. Our Convertible Notes and Promissory Note outstanding at

December

31,

2016

do not have a readily available ascertainable market value, however, the carrying value is considered to approximate its fair value.

Concentration of Credit Risk

Cash, cash equivalents and short-term investments are financial instruments that potentially subject us to concentrations of credit risk. We deposit our cash in financial institutions. At times, such deposits

may

be in excess of insured limits. We

may

also invest our excess cash in money market funds, corporate debt securities and commercial paper. We have established guidelines relative to our diversification of our cash investments and their maturities in an effort to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates.

Sales to ASD Specialty Healthcare, Inc., Cardinal Health, Inc. and McKesson Specialty Care Distribution Corporation each accounted for

10%

or more of our net revenues for the year ended

December

31,

2016.

The loss of any of these customers could materially and adversely affect our business, results of operations, financial condition and cash flows.

Inventory

Inventory is stated at the lower of cost or estimated net realizable value, on a

first

-in,

first

-out, or FIFO, basis. We periodically analyze our inventory levels, and write down inventory that has become obsolete, inventory that has a cost basis in excess of its estimated realizable value and inventory quantities that are in excess of expected sales requirements as cost of product sales. The determination of whether inventory costs will be realizable requires estimates by management. If actual market conditions are less favorable than projected by management, additional write-downs of inventory

may

be required, which would be recorded as cost of product sales.

We capitalize pre-launch costs into inventory when we believe it is probable that: (i) a future economic benefit will be derived from the commercialization of the product; (ii) the FDA will approve the marketing of the product; and (iii) our process for manufacturing the product is within the specifications that we believe will be approved by the FDA for such product. In evaluating whether it is probable that we will derive future economic benefits from our pre-launch inventories and whether the pre-launch inventories are stated at the lower of cost or net realizable value, we consider, among other things, the remaining shelf life of that inventory, the current and expected market conditions, the amount of inventory on hand, and the substance of communications with the FDA during the regulatory approval process.

For the year ended

December

31,

2016,

we recognized cost of sales of

$35,000

for sales of SUSTOL, primarily related to shipping and distribution costs. All SUSTOL units sold in

2016

were manufactured prior to the approval of SUSTOL, and the costs to manufacture such units were recorded to research and development expense in prior periods.

Property and Equipment

Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets (primarily

five

years). Leasehold improvements are stated at cost and amortized on a straight-line basis over the shorter of the estimated useful life of the asset or the lease term.

Impairment of Long-Lived Assets

If indicators of impairment exist, we assess the recoverability of the affected long-lived assets by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows. If impairment is indicated, we measure the amount of such impairment by comparing the carrying value of the asset to the fair value of the asset and record the impairment as a reduction in the carrying value of the related asset with a corresponding charge to operating expenses. Estimating the undiscounted future cash flows associated with long-lived assets requires judgment and assumptions that could differ materially from actual results.

Revenue

Recognition

Product

Sales

SUSTOL is distributed in the U.S. through a limited number of specialty distributors (“Customers”) that resell SUSTOL to healthcare providers, the end users of SUSTOL. Product sales are recorded net of sales allowances and estimated rebates, chargebacks, distributor fees, and other deductions.

Product sales are recognized as revenue when there is persuasive evidence that an arrangement exists, delivery has occurred and title has passed, the price is fixed or determinable and we are reasonably assured of collecting the resulting receivable. Product sales are recorded net of sales allowances and estimated rebates, chargebacks, distributor fees, and other deductions. Due to the recent launch of SUSTOL, we do not yet have sufficient historical data regarding the

third

-party payor mix and resulting rebates related to shipments of SUSTOL to our Customers. In addition, we have further determined that we do not currently have the necessary data to provide sufficient visibility into the ultimate utilization of SUSTOL, which inhibits our ability to determine a reasonable estimate of potential returns. As a result of the above, we have determined that we are not yet able to reliably make all of the estimates necessary to meet certain of the key recognition criteria to recognize product sales as revenue with respect to shipments of SUSTOL to our Customers. Accordingly, we concluded that revenue related to shipments to our Customers should be deferred, except to the extent that our Customers have resold SUSTOL to healthcare providers. As of

December

31,

2016,

product sales of

$1.1

million to our Customers have been deferred and are recorded as deferred revenue on our consolidated balance sheet.

Product Sales Allowances

We recognize product sales allowances as a reduction of product sales in the same period the related revenue is recognized. Product sales allowances are based on amounts owed or to be claimed on the related sales. These estimates take into consideration the terms of our agreements with Customers, historical product returns, rebates or discounts taken, the shelf life of the product, and specific known market events, such as competitive pricing and new product introductions. If actual future results vary from our estimates, we

may

need to adjust these estimates, which could have an effect on product sales and earnings in the period of adjustment. Our product sales allowances include:

●

Product Returns — We allow our Customers to return product for credit

months after its product expiration date. Because of the shelf life of our product and our return policy, there

may

be a significant period of time between the time the product is shipped and the time the credit is issued on returned product.

●

Distributor Fees — We offer contractually determined discounts to our Customers. These discounts are paid on a quarterly basis within

two

months after the quarter in which product was shipped.

●

Group Purchasing Organization (“GPO”) Discounts and Rebates — We offer cash discounts to GPO members. These discounts are taken when the GPO members purchase SUSTOL from our Customers, who then charge back to us the discount amount. Additionally, we offer volume and contract-tier rebates to GPO members. Rebates are estimated based on actual purchase levels during the quarterly or semi-annual rebate purchase period.

●

GPO Administrative Fees — We pay administrative fees to GPO’s for services and access to data. These fees are based on contracted terms and are paid after the quarter in which the product was purchased by the GPO’s members.

●

Medicaid Rebates — We participate in Medicaid rebate programs, which provide assistance to certain low-income patients based on each individual state's guidelines regarding eligibility and services. Under the Medicaid rebate programs, we pay a rebate to each participating state, generally within

three

months after the quarter in which SUSTOL was sold.

We believe our estimated allowance for product returns requires a high degree of judgment and is subject to change based on our experience and certain quantitative and qualitative factors. We believe our estimated allowances for distributor fees, GPO discounts, rebates and administrative fees, and Medicaid rebates do not require a high degree of judgement because the amounts are settled within a relatively short period of time.

Our product sales allowances and related accruals are evaluated each reporting period and adjusted when trends or significant events indicate that a change in estimate is appropriate. Changes in sales allowance estimates could materially affect our results of operations and financial position. As of

December

31,

2016,

our product sales allowances totaled

$342,000,

which included

$72,000

for distributor fees,

$221,000

for rebates and chargebacks and

$49,000

for product returns. During the year ended

December

31,

2016,

we made

payments related to rebates, chargebacks or product returns.

Accrued Clinical Liabilities

We accrue clinical costs based on work performed, which relies on estimates of the progress of the trials and the related expenses incurred. Clinical trial related contracts vary significantly in duration, and

may

be for a fixed amount, based on the achievement of certain contingent events or deliverables, a variable amount based on actual costs incurred, capped at a certain limit, or contain a combination of these elements. Revisions are recorded to research and development expense in the period in which the facts that give rise to the revision become known. Historically, revisions have not resulted in material changes to research and development expense, however, a modification in the protocol of a clinical trial or cancellation of a trial could result in a material charge to our results of operations.

Research and Development Expenses

All costs of research and development are expensed in the period incurred. Research and development costs primarily consist of salaries and related expenses for personnel, stock-based compensation expense, fees paid to outside service providers and consultants, facilities costs and materials used in the clinical and preclinical trials and research and development.

Patent Costs

We incur outside legal fees in connection with filing and maintaining our various patent applications. All patent costs are expensed as incurred and are included in general and administrative expense in the consolidated statements of comprehensive loss.

Stock-Based Compensation Expense

We estimate the fair value of stock-based payment awards using the Black-Scholes option pricing model. This fair value is then amortized using the straight-line single-option method of attributing the value of stock-based compensation to expense over the requisite service periods of the awards. The Black-Scholes option pricing model requires the input of complex and subjective assumptions, including each option’s expected life and price volatility of the underlying stock.

As stock-based compensation expense is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical data.

Warrants

We have issued warrants to purchase shares of our common stock in conjunction with certain equity financings. The terms of the warrants were evaluated to determine the appropriate classification as equity or a liability.

Income Taxes

We recognize the impact of a tax position in our consolidated financial statements if the position is more likely than not to be sustained upon examination and on the technical merits of the position. The total amount of unrecognized tax benefits, if recognized, would affect other tax accounts, primarily deferred taxes in future periods, and would not affect our effective tax rate since we maintain a full valuation allowance against its deferred tax assets (see Note

9).

Comprehensive

Loss

Comprehensive loss is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources.

Unrealized gains and losses on available-for-sale securities are included in other comprehensive loss and represent the difference between our loss and comprehensive net loss for all periods presented.

Earnings per Share

Basic earnings per share (“EPS”) is calculated by dividing the net loss by the weighted-average number of common shares outstanding for the period, without consideration of common share equivalents. Diluted EPS is computed by dividing the net loss by the weighted-average number of common shares and common share equivalents outstanding for the period determined using the treasury stock method. For purposes of this calculation, stock options, warrants and common stock underlying Convertible Notes are considered to be common stock equivalents and are included in the calculation of diluted EPS only when their effect is dilutive.

Because we have incurred a net loss for all periods presented in the consolidated statements of comprehensive loss, stock options, warrants and shares of common stock underlying Convertible Notes are not included in the computation of net loss per share because their effect would be anti-dilutive.

The following table includes the number of stock options, warrants and shares of common stock underlying Convertible Notes not included in the computation as of the dates shown below (in thousands):

	As of December 31 ,
	2016		2015		2014

Stock options outstanding		11,845		8,435		7,918
Warrants outstanding		600		3,565		4,108
Shares of common stock underlying Convertible Notes outstanding		7,521		7,087		6,677

Recent Accounting Pronouncements

March

2016,

the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No.

2016

09,

Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting

(“ASU

2016

09”).

ASU

2016

addresses several aspects of the accounting for share-based payment award transactions, including: (a) income tax consequences; (b) classification of awards as either equity or liabilities; and (c) classification on the statement of cash flows. ASU

2016

is effective for fiscal years beginning after

December

15,

2016,

including interim periods within those fiscal years. We plan to adopt the provisions of ASU

2016

in the

first

quarter of

2017.

We do not expect the adoption of ASU

2016

to have a material impact on our results of operations or financial condition.

February

2016,

FASB issued ASU No.

2016

02,

Leases

(“ASU

2016

02”).

ASU

2016

requires a lessee to record on the balance sheet the assets and liabilities for the rights and obligations created by leases with lease terms of more than

months. In addition, ASU

2016

requires both lessees and lessors to disclose certain key information about lease transactions. ASU

2016

is effective for fiscal years beginning after

December

15,

2018,

including interim periods within those fiscal years. We plan to adopt the provisions of ASU

2016

in the

first

quarter of

2019

and we are currently evaluating the impact on our results of operations and financial condition.

July

2015,

FASB issued ASU No.

2015

11,

Inventory (Topic

330)

(“ASU

2015

11”).

ASU

2015

requires entities to measure inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predicable costs of completion, disposal and transportation. Subsequent measurements are unchanged for inventory measured using LIFO or the retail inventory method. ASU

2015

is effective for fiscal years beginning after

December

15,

2016,

and interim periods within fiscal years beginning after

December

15,

2017.

We plan to adopt the provisions of ASU

2015

2017.

We do not expect the adoption of ASU

2015

to have a material impact on our results of operations or financial condition.

August

2014,

FASB issued ASU No.

2014

15,

Presentation of Financial Statements – Going Concern (Subtopic

205

40)

(“ASU

2014

15”).

ASU

2014

requires management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments

(1)

provide a definition of the term substantial doubt,

(2)

require an evaluation every reporting period, including interim periods,

(3)

provide principles for considering the mitigating effect of management’s plans,

(4)

require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans,

(5)

require an express statement and other disclosures when substantial doubt is not alleviated, and

(6)

require an assessment for a period of

one

year after the date that the financial statements are issued (or available to be issued). The amendments in ASU

2014

are effective for the annual period ending after

December

15,

2016,

and for annual periods and interim periods thereafter. We adopted the provisions of ASU

2014

2016.

The adoption of ASU

2014

did not require any additional disclosures in our consolidated financial statements for the year ended

December

31,

2016.

May

2014,

FASB issued ASU No.

2014

09,

Revenue from Contracts with Customers (Topic

606)

(“ASU

2014

09”).

ASU

2014

is based on the principle that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU

2014

is effective for fiscal years beginning after

December

15,

2017,

including interim periods within those fiscal years. The provisions of ASU

2014

allows for either a full retrospective or a modified retrospective adoption approach. We plan to adopt the provisions of ASU

2014

in the

first

quarter of

2018

and we are currently evaluating the impact on our results of operations and financial condition.