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LivaNova PLC (NASDAQ:LIVN)
Q4 2020 Earnings Call
Feb 24, 2021, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and thank -- and welcome to the LivaNova PLC Fourth Quarter and Full Year 2020 Earnings Conference Call. [Operator Instructions]

I would now like to introduce your host for today's conference, Mr. Matthew Dodds, LivaNova's Senior Vice President of Corporate Development. Please go ahead, sir.

Matthew Dodds -- Senior Vice President, Corporate Development

Thank you, Catherine. And welcome to our conference call and webcast discussing LivaNova's financial results for the fourth quarter and full year 2020. Joining me on today's call are Damien McDonald, our Chief Executive Officer; Alex Shvartsburg, our Interim Chief Financial Officer; and Melissa Farina, our Vice President of Investor Relations.

Before we begin, I would like to remind you that the discussions during this call will include forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company's most recent filings and documents furnished to the SEC, including today's press release that is available on our website. We do not undertake to update any forward-looking statement.

Also the discussions will include certain non-GAAP financial measures with respect to our performance, including but not limited to sales results, which will all be stated on a constant currency basis. Reconciliations to the most directly comparable GAAP financial measures can be found in today's press release which is available on our website. We have also posted a presentation to our website that summarizes the points of today's call. This presentation is complementary to our other call materials and should be used as an enhanced communication tool. You can find the presentation and press release in the Investors section of our website under News and Events and Presentations at investor.livanova.com.

With that I will now turn the call over to Damien.

Damien McDonald -- Chief Executive Officer

Thanks, Matt, and thank you for joining us. And I hope you and your families continue to remain safe and healthy during these challenging times. Welcome to our fourth quarter and full year 2020 conference call. As you are aware, we have a large employee population in Houston, all of whom were impacted by the storms last week. I am relieved that everyone is safe and we'd like to thank all of them for their dedication and ingenuity to keep our operations running.

Today we will discuss our results and provide recent company updates, including guidance for 2021 and the first quarter. The COVID-19 pandemic has presented unique operating challenges. Many markets around the world have operated inconsistently or shutdown for varying periods of time and this dynamic has continued in the fourth quarter and thus far into 2021.

I'm going to start off by discussing some recent updates to our business and Board structure, then move to sales results focusing on the primary growth drivers Epilepsy and ACS. Then I will discuss our strategic portfolio initiatives DTD, Heart Failure and OSA. After my comments, Alex will provide you with additional details on the results and our 2021 guidance, which continues to include heart valves. Then I will wrap up with closing comments before moving on to Q&A.

In December LivaNova entered into an agreement with Gyrus Capital for the sale of the Heart Valve business. This portfolio will benefit from the ownership of Gyrus and its ability to singularly focus on building a Heart Valve business. This will enable us to sharpen our focus on the primary cardiovascular and neuromodulation platforms. As you know divestitures are complex and we are currently discussing an amendment to the purchase agreement with Gyrus related to a deferred closing of a subsidiary that is responsible for site management services at the Saluggia campus. We continue to expect the initial closing consisting of the Heart Valve operations in Italy and Canada to occur in the second quarter, followed by closings of the sales infrastructure in the second half of the year.

In December, we announced a series of Board Leadership Changes, driven by the Nominating and Corporate Governance Committee. Included in those changes, Todd Schermerhorn was appointed to the Board of Directors. Todd has 35 years of experience in Global Health Care, including 27 years at C.R. Bard, where he held positions of increasing responsibility, which culminated with his nine year tenure as Chief Financial Officer. He currently serves on the boards of Metabolon and also Travelers Company, where he is the Independent Lead Director and chairs its Risk Committee. Todd will succeed Hugh Morrison has Audit Chair upon Hugh's retirement at the 2021 AGM. Additionally, we will be rotating the Board and two committee chairs following the 2021 AGM. We believe all these changes underscore our commitment to leading corporate governance and to help further enhance the Board's independent oversight.

Now I'll discuss the core growth drivers, Epilepsy and ACS. All net sales results will be stated on a constant currency basis. Epilepsy sales declined 4% globally versus the fourth quarter of 2019. This decrease is attributable to the impact of COVID-19 on both new patient and end-of-service or replacement implants. Importantly sales rose sequentially and were in line with our full year guidance range. US Epilepsy declined in the mid single-digits and implants continued to improve sequentially over the third quarter. In the fourth quarter, Epilepsy sales in Europe reached nearly 90% of our prior year levels with strong performance in the Nordic region and Spain. The Rest of World region grew 11% as a strong growth in the Middle East and Australia as non-emergent procedures recovered. For the full year 2021, we expect global Epilepsy sales to grow at 15% to 20%, including strong growth in new implants as patients return to their physicians and we expect the tailwind in replacement implants related to the backlog created in 2020. We are pleased with the progress of the go-to-market initiative and still plan on adding three new dedicated teams in the US during 2021.

ACS sales were $13 million in the quarter, an increase of 50% from the fourth quarter of 2019. Growth was driven by the adoption of LifeSPARC and an increase in acute respiratory distress related procedures. We continue to expect ACS to grow at least 20% in 2021.

Turning now to DTD. Sales in the fourth quarter were $1 million and $7 million for the full year. In 2021, we expect DTD sales of approximately $10 million to $15 million from a combination of the RECOVER study and the replacement implants for CMS eligible patients. We continue to expect to reach 250 unipolar patients and/or 150 bipolar patients implanted in their respective RECOVER study arms by year-end.

In Heart Failure, the ANTHEM HFrEF US pivotal trial continues to progress with over 265 patients enrolled. We still expect to achieve 300 patients enrolled in the first half of 2021. We continue to make progress in OSA. The confirmatory study was submitted for IDE approval during the fourth quarter. We received some additional questions and still expect to start the study in mid 2021. For the Cardiopulmonary business, sales were $122 million in the quarter, a decline of 10% versus the fourth quarter of 2019. Oxygenators declined in the low double-digits globally as the faster recovery in the procedure volumes in the US and the Rest of World region was offset by procedure restrictions in Europe. HLM sales declined in the high single-digits due to COVID-19 impacts on hospital budgets for capital equipment and all regions improved sequentially over the third quarter.

Moving to Heart Valves. Sales for this segment were $24 million in the quarter, a decrease of 27% versus the fourth quarter of 2019, including another double-digit growth quarter in Japan, driven by Perceval. Starting in the second quarter of 2020 and continuing through the year, we reduced costs to offset some of the decline in sales. We continue to reallocate resources to fund priorities. These actions have delivered approximately $65 million in savings in 2020. Specifically, these four key areas included the following: first, we instituted a hiring freeze, participated in government sponsored work programs and adjusted employee-related expenses, including lower performance-based compensation and a significant reduction in Executive Leadership short-term incentive. Second, we reduced spend related to travel, marketing events and field presence and have shifted to working with our customers and stakeholders using remote methods. Third, we reduced other discretionary spend related to external consulting and temporary staffing and fourth, we balanced our manufacturing output to coincide with the anticipated reduction in demand. We remain focused on disciplined control of expenses as we move through this next phase of the pandemic, while still investing in our pipeline initiatives.

I'll now turn the call over to Alex for an overview of the financial results. Alex?

Alex Shvartsburg -- Interim Chief Financial Officer

Thank you. Thank you, Damien. I'm going to discuss the fourth quarter results in greater detail and then provide our 2021 guidance. Sales in the quarter were $270 million and declined 7.7% compared to the fourth quarter of 2019. Cardiovascular sales were $160 million, down 10.1% for the fourth quarter of 2019. Neuromodulation sales were $109 million, a decline of 3.8% compared to the fourth quarter of 2019. Adjusted gross margin as a percent of net sales in the quarter was 67.2%, down 250 basis points from the fourth quarter of 2019. The margin decline was primarily driven by lower volume from sales and unfavorable manufacturing variances. Adjusted R&D expense in the fourth quarter was $39 million compared to $38 million in the fourth quarter of 2019. R&D as a percent of net sales was 14.5% versus 13.1% in the fourth quarter of 2019. R&D is increasing behind continued progress of the ANTHEM HFrEF pivotal trial and the RECOVER study.

Adjusted SG&A expense for the fourth quarter was $94 million compared to $108 million in the fourth quarter of 2019. SG&A as a percentage of net sales was 34.7%, down from 37.4% in the fourth quarter of 2019. Adjusted operating income from continuing operations was $49 million compared to $55 million in the fourth quarter of last year. Adjusted operating income margin from continuing operations was 18% compared to 19.2% in the fourth quarter of 2019. The adjusted effective tax rate in the quarter was negative 0.1% compared to 5.3% in the fourth quarter of 2019. The lower tax rate is primarily attributable to geographic income mix and partial valuation allowance in the US.

Finally adjusted diluted earnings per share from continuing operations in the quarter was $0.71 compared to $1 in the fourth quarter of 2019, and was within the full-year guidance range.

Moving to cash flow, the cash balance at December 31, 2020 was $253 million, up from $61 million at December 31, 2019. Net debt at quarter end was approximately $505 million, up from $272 million at year-end 2019. These changes reflect the impact of the financing completed in the second quarter of 2020. Our adjusted free cash flow, excluding extraordinary items through the fourth quarter of 2020 was $17 million. Capital spending for 2020 was $35 million, which was $10 million higher than 2019 related to initiatives to support manufacturing, sterilization capabilities and to further develop our Epilepsy digital innovation platform.

As a result of the Heart Valve divestiture, we took a charge of $202 million in the fourth quarter related to the anticipated sale of the Heart Valve business. In addition, we have reserved $42 million for a provision for future obligations of our site management subsidiary related to hazardous substances from former operations at Saluggia, Italy campus.

Now turning to 2021 guidance. We forecast 2021 sales growth between 8% and 13% on a constant currency basis and this includes the full year of the Heart Valve business. If current exchange rates remain unchanged, the company's full year revenue guidance will be positively impacted by less than 1%. We anticipate the Neuromodulation business to grow 15% to 20%. We estimate our Cardiovascular franchise to grow in the low to mid single-digits, with strong growth from ACS, largely offset by late stage replacement cycle of HLM. We are projecting adjusted diluted earnings per share from continuing operations in the range of $1.40 to $1.90. The share count is expected to be approximately 49 million. Adjusted cash flow from operations, excluding extraordinary items is expected to be in the range of $30 million to $50 million.

While we don't provide quarterly guidance, sales in the first half are assumed to be lower, while expenses are generally more evenly spread out. For the first quarter of 2021, we expect net sales to be down 3% to 7%. The first quarter is expected to be the softest earnings quarter and we forecast a range of $0.10 to $0.20 per share.

With that, I'll turn the call back to Damien for some final comments.

Damien McDonald -- Chief Executive Officer

Thanks, Alex. While 2020 did not go as expected, we have become stronger, more agile and remain cautiously optimistic that our execution focus coupled with expectations of declining COVID-19 infections rates will lead to improving results throughout the year. As we transition out of the pandemic, we believe customers will continue to reward both our innovation actions as valued partners with increased trust and market share. As procedures return, we believe the work we've been doing to improve margins will become clear. We look forward to updating you on our continued progress and delivering on our commitments to drive shareholder value.

And with that Catherine, we're open for questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Rick Wise with Stifel. Your line is open.

Rick Wise -- Stifel -- Analyst

Thank you and good morning to all. Damien, maybe I'll start off just with recent trends. Obviously we've all been hearing in recent days and weeks about the weakness, COVID driven weakness in general for everybody in late December and into January. Can you give us a little more color on recent trends and just what you're seeing, have things stabilized? Are you seeing -- is it getting worse or better as you -- you're now to way -- two-thirds of the way through the first quarter? Just any additional color if you could?

Damien McDonald -- Chief Executive Officer

Yes. First of all, good morning, Rick. Lovely to have you on. Fourth quarter, look the fourth quarter was interesting year-over-year, October was the strongest and then we faced headwinds like a lot of people in mid-November that carried into December, especially Europe, I mean that was the noisiest for us. And you can see that in some of the commentary we just gave, sales in the first quarter really continued that trend with the COVID-19 hospitalizations increasing, comparison start getting easier in March, but Q1 is being noisy, to say the least.

Rick Wise -- Stifel -- Analyst

I -- I'm sorry, noisy meaning, can you give us any more color? Are you feeling a bit more optimistic? Many companies have talked about recovery or some have cited some signs of light at the end of the tunnel, kind of thing. Anything else you can share?

Matthew Dodds -- Senior Vice President, Corporate Development

Hey, Rick. It's Matt. So I would say, what we're seeing is similarly we've heard from lot of other companies, it wasn't as bad in Jan, Feb as maybe it was last year in like April, May. The hospitals were just better situated, especially in the US. It has been a little tougher in Europe. Europe didn't rebound as much. We have seen International remain in pretty good shape, probably they came off of in the last -- at the end of last quarter. And I would say there were slightly improving trends in February, but last week and the week before with weather and what happened in Houston, that looked like a temporary setback. So I'd say, the next two weeks we'll know a lot more.

Rick Wise -- Stifel -- Analyst

Okay. And turning to the RECOVER trial enrollment timelines and milestones, I heard you correctly, Damien and please correct me if I'm wrong. The 250 unipolar or 150 rather -- 55 [Phonetic], did you say bipolars by the end of '21, it sounds like enrollment, if I'm hearing you correctly, is very much on track sort of with expectations or guidance or comments we've heard in recent months. Am I understanding that correctly. To what extent are we seeing headwinds there? Are you concerned about these tight [Phonetic] months?

Damien McDonald -- Chief Executive Officer

Yes, you are hearing that right, yes. 250 in the unipolar or 150 in the bipolar or both. We actually thought that the bipolar was not going to recruit as fast because it's just harder to have deal with those patients and track them, but it turns out that has been a faster recruiting timeline than we anticipated. So it's tracking well. The implants are progressing well. The consents into the trial have been really progressing well. Again, the limiting factor is just clinics being open to implant, which as you know from some of the studies, neurology, psychiatry visit to clinics are lower, whereas a lot of the telehealth is progressing very, very well. So I like the progression there. The consents are definitely tracking extremely well and I'm pleased with how the teams doing that study and following up on the existing patients that we've already implanted. We've not missed a titration or follow up yet.

Rick Wise -- Stifel -- Analyst

That's great, you said, one and a follow-up. I'll stop there. Thank you.

Operator

Thank you. Our next question comes from...

Damien McDonald -- Chief Executive Officer

Thanks Rick.

Operator

Thank you. Our next question come from Anthony Petrone with Jefferies. Your line is open.

Anthony Petrone -- Jefferies -- Analyst

Great. Thank you and good morning everyone. Hope everyone's healthy. Maybe just a couple on guidance. The negative 18% [Phonetic] -- negative 8% to 13% all baked in, what is actually baked in there for Heart Valves? Just trying to get some math as we exclude that. And then in terms of the neuromod outlook 15% to 20%, just trying to get a sense of how much COVID recoveries reflected in that versus new patient starts? And then even reimplants, from the 100,000 existing base. How much -- how many -- how do you reflect reimplants, and that as well? Thanks.

Damien McDonald -- Chief Executive Officer

First of all, let me just say welcome Anthony. Great to have you tracking us. And I'll pass this to Alex.

Anthony Petrone -- Jefferies -- Analyst

Thank you.

Alex Shvartsburg -- Interim Chief Financial Officer

Yes. So from a sales perspective, Heart Valves ended 2020 at roughly, call it $90 million in sales. We expect a recovering from Heart Valves sort of low to mid double-digits. I would say. So that's kind of a good way to forecast the Heart Valve business. And right now we have it in for the full year, but as we said, we expect to close the transaction sometime in the second quarter.

Matthew Dodds -- Senior Vice President, Corporate Development

And it's Matt, for neuromod the 15% to 20%, I would say, a little bit of that is DTD, that's up year-over-year. If you look at Epilepsy, what we've been saying is at least 5% underlying is our plan, hopefully a little better, higher OUS because that's a global number and then don't forget, the US is 75%. So it's mostly driven by the US. So if you take those pieces, you can kind of see what the difference is in terms of what we consider to be the snapback. And our thought right now is more of that's going to come from the replacement or end of service in the NPI.

Anthony Petrone -- Jefferies -- Analyst

That's helpful, thanks. Happy to be on-board. I'll hop back in queue.

Matthew Dodds -- Senior Vice President, Corporate Development

Happy to have you.

Operator

Thank you. Our next question comes from Adam Maeder with Piper Sandler. Your line is open.

Adam Maeder -- Piper Sandler -- Analyst

Hey guys. Thanks for taking the questions here. I wanted to start with just a couple of housekeeping questions. Just first, it sounds like you gave an incremental update on the pending Heart Valve divestiture. But I want to make sure I better understand that. So -- and I know the divestiture isn't contemplated in the guide, but how do we think about any potential impact there in terms of dilution once that's final? And then the second housekeeping question is just, any update or more color you can share on the CFO search and where that stands today? And then I had one follow-up. Thanks.

Alex Shvartsburg -- Interim Chief Financial Officer

Hey, Adam. It's Alex. On the Heart Valve divestiture as we stated previously, we expect the full-year impact to be about $0.10 to $0.15 dilutive. So that's the way obviously given the timeline I would model it in that fashion, pro-rated as you see it.

Damien McDonald -- Chief Executive Officer

And with respect to the CFO search, two things. First of all, the end of the year is an interesting time to be recruiting for senior executive, because it's bonus reporting Ks and Qs for most companies. So that role has a stickiness that I think is interesting when you're recruiting. Having said that, our partner, which is a large global human resources partnership have on us a really intriguing pack of candidates, many of whom we've met over the last several months. Having said that, I will say, I'm fortunate and I think we're fortunate as a company to have Alex being able to step into the role and he is making the tangible and palpable difference to the function. And so as we continue the search, I'm convinced that we have the right person to be filling the seat.

Adam Maeder -- Piper Sandler -- Analyst

Thanks guys. It's very helpful. And then for the follow-up, just one on the '21 guidance. The EPS guide to me was, I guess a bit below, I expect -- than I expected and perhaps that's some mismodeling on my behalf. But the guidance range is pretty wide. So it would be helpful to kind of better understand kind of how you arrived at the top and the bottom end of the EPS outlook? And then maybe just talk about the cost initiatives that you had in 2020, the savings there. What's going to carry over into 2021? And then just talk a little bit about kind of employee morale and turnover? Thanks so much guys.

Alex Shvartsburg -- Interim Chief Financial Officer

Okay. Adam, so from a margin profile perspective, the gross margin is actually increasing in 2021. And then once Heart Valves -- Heart Valves out of our P&L, we expect about 200 basis points of accretion. Relative to 2020, gross margin is increasing on the basis of improved mix from VNS and increased volumes in CP. R&D as a percent of sales is going to increase in 2021. This is largely due to the RECOVER and the ANTHEM trials. Also, just to remind you in 2020, we had sort of a depressed spending base. So there is a little bit of an increase there as well. SG&A as a percent of sales is going to decrease in 2021 versus 2020. It's just pure economies of scale as sales increase and we see some leverage there. Then I guess, interest expense, we continue to look at $45 million to $50 million and the tax rate in the range of 10% to 15%.

Matthew Dodds -- Senior Vice President, Corporate Development

Adam, and I'd say versus consensus, it's a little tricky, because, couple of you have Heart Valves out, but what we really try to look at apples-to-apples, I'd say the major differences to Alex's point, it's R&D and SG&A, that's where we see our numbers a little bit ahead of the street as a percent of sales.

Damien McDonald -- Chief Executive Officer

Just on employee morale, it's a great question. So first of all, let me talk about data. Sequentially, we saw an improvement in our voluntary turnover rate quarter-on-quarter. So I'm pleased that we are heading in the right direction there. Secondly, we conducted our Virtual Growth and Leadership Conference, which brings together 150 of our senior leadership over three days in December and January, and reading the chat line on this virtual conference, I'm convinced, we have a highly motivated senior leadership team. More broadly, I'd say the organization is faced into the challenges of 2020 and even the start of 2021 with the weather and continued COVID with extreme positivity, and again, I just look at how people reacted with ingenuity to the freezing weather in Houston, and I'm convinced that we've got a team that's highly motivated and really linked to our mission of patients first.

Adam Maeder -- Piper Sandler -- Analyst

That's really helpful, guys. Thanks for taking all the questions and appreciate the awesome response. Thank you.

Damien McDonald -- Chief Executive Officer

Thanks Adam.

Operator

Thank you. Our next question comes from Michael Polark with Baird. Your line is open.

Michael Polark -- Robert W. Baird -- Analyst

Good morning, good afternoon. I have several follow-ups to some of the prior questions. Just a clarification. I heard on -- in the slides, the slide deck says for Cardiovascular revenue up mid to high single-digits in 2021. And then, Alex, I think in your prepared comment, you said low to mid, my sense is the variance there is with and without Heart Valves or perhaps I misheard. So can you just clarify, those two titbits for me?

Alex Shvartsburg -- Interim Chief Financial Officer

Yes, so Cardiovascular, we expect to grow low to mid single-digits, kind of in line with the normal growth that you would see from the marketplace. As I mentioned before, we expect the Heart Valve business to have a larger snapback. So expect somewhere between, I would say, low to mid double-digit snapback on Heart Valve. So that's kind of how we adjust for it.

Michael Polark -- Robert W. Baird -- Analyst

Okay. The slide deck, Page 21, says Cardiovascular up mid to high single-digits. So I just want to -- but that's the genesis of the question I'm hearing differently from you, then I see in the slides, but maybe we can take that offline. And I think I get the components, that just several moving pieces. I don't want to make sure we're anchored appropriately. On Heart Valves, the earnings $0.10 to $0.15 of run rate dilution, let's assume that does divest middle of this year as you indicated. Does your -- and I know it's in your revenue guidance today. But does your earnings guidance absorb that dilution when it finally hits?

Alex Shvartsburg -- Interim Chief Financial Officer

No, no, it does not.

Michael Polark -- Robert W. Baird -- Analyst

Okay. Okay. In the slide deck on the free cash flow Slide 20, there is a -- for the 2021 forecast there is a dotted lined gray box and I want to understand what is that? It seems to be an extraordinary item and I want understand what that is and what the number is?

Alex Shvartsburg -- Interim Chief Financial Officer

Just a range, really. That's all it is.

Michael Polark -- Robert W. Baird -- Analyst

Got it. Okay. So the...

Alex Shvartsburg -- Interim Chief Financial Officer

It's showing the $30 million to $50 million range, yes.

Michael Polark -- Robert W. Baird -- Analyst

Okay. Okay. Okay, understood. On the -- on R&D, I mean, look, it's, I appreciate that comment clearly Street was and myself under modeling the spend in 2021 peak period for both of those important studies. Can you put a finer point on what is the dollar investment expected or what is -- what are your R&D dollars in your model in 2021, because I would imagine in '22 and beyond that we back off if this is indeed peak spend year for ANTHEM and RECOVER. So just trying to -- it's a little bit of a pop in that number and then will fade. I would imagine in the out years. So if you could put a finer point on that, I think that would be helpful?

Alex Shvartsburg -- Interim Chief Financial Officer

I'll quote a range of 16% to 17% of sales.

Michael Polark -- Robert W. Baird -- Analyst

Okay, all right, last one. It sounds like the RECOVER recruitment is on track and the comments clear, does that keep you on pace for the prior timing of the late 2022, early 2023 flip to registry. My guess is, yes, but I want to ask the question?

Damien McDonald -- Chief Executive Officer

Yes, yes. So short answer is yes.

Michael Polark -- Robert W. Baird -- Analyst

Okay. All right. Thank you very much.

Damien McDonald -- Chief Executive Officer

All right Mike, cheers.

Operator

Thank you. Our next question comes from Scott Bardo with Berenberg. Your line is open.

Damien McDonald -- Chief Executive Officer

Hey Scott. How are you?

Scott Bardo -- Berenberg -- Analyst

Hey, not too bad, thanks Damien. Thanks for taking the questions. [Indecipherable] used to provide some EBIT margin range and place it with new guidance, so I know you've just -- Alex given some parts of the pieces, but the nature of my question is, your sales guidance looks to be I think quite encouraging highlighting a return to more normalized activities. If I understand correctly, your earnings guidance implies something like a 13% to 16% margin guidance. I wonder firstly, can you clarify whether that makes sense. And following up from that, one of your key strategic priorities I think is to optimize operating costs and it seems a little perverse to me why -- while your top line recovers as guided, why you're expecting margins to be materially below 2019 even without the divestiture of Heart Valves, which I think is margin accretive. So I just want to talk about these parts. And I think it is important, because Damien you've highlighted many, many times an aspiration to shoot toward the 20% margin bandwidth, which seems achievable given your gross margin. Of course, there is great uncertainty as to a timeline around that. So if you could please help us with those pieces. I think that's important. Thanks.

Operator

One moment. Speakers, please go ahead.

Damien McDonald -- Chief Executive Officer

Hi, how are you? So we lost Scott there.

Scott Bardo -- Berenberg -- Analyst

Okay. Can you hear me OK.

Damien McDonald -- Chief Executive Officer

Yes, Catherine, we've got back Scott, sorry, we lost you there.

Scott Bardo -- Berenberg -- Analyst

I'm sorry for that. Okay. I will summarize the question again. Your guidance implies good top line dynamic and a recovery of the top line, but it seems to me that your earnings guidance suggests that your margins are going to be below 2019, quite materially below 2019. And that seems a bit of a disconnect, given your statements about trying to maximize operational profit and improve efficiencies. So I guess the nature of the question is, can you help us understand what margin is implied within your guidance and when, in your view we take the path toward back to a 20% margin, which is your current mid-term guidance for 2022? Thank you.

Damien McDonald -- Chief Executive Officer

Scott, thanks for your question. So our adjusted margin, we're expecting somewhere between 13% to 14%. That's kind of where we're coming in. Again the major investments in R&D are kind of try driving the -- I guess you could call it the dilutive effect of these investments. We're making good progress in terms of reallocating costs. It's going to take us a little bit of time to work through some of the cost containment initiatives that we've highlighted in the past. So that's kind of the plan at this point.

Matthew Dodds -- Senior Vice President, Corporate Development

Yes. Scott, it's Matt. Our plan is to improve obviously from '21 going forward each year. We are tentatively planning our Capital Markets Day in the back half of this year and we're going to give you more color on the margin over a longer term horizon and then specifically that 20% number will be very clear on the year, we expect to get back to that.

Scott Bardo -- Berenberg -- Analyst

Thank you. But I mean following on for one of the questions before then, is it fair to say we are then at peak R&D on an absolute basis and that should normalize going forwards. Is that a fair statement?

Matthew Dodds -- Senior Vice President, Corporate Development

Yes, exactly Scott.

Scott Bardo -- Berenberg -- Analyst

All right. And maybe just one last question on free cash flow, please. I think that it's encouraging of course to see that you're expecting some progression in free cash flow, but the free cash flow numbers being guided are still 25% of adjusted free cash flow guidance that would have been given at this time last year. So why is free cash flow so poor and when do we actually see a convergence toward your historic free cash flow guidance? Thanks.

Alex Shvartsburg -- Interim Chief Financial Officer

So, Scott, just want to remind you, in the third quarter, we changed the definition of free cash flow. Our free cash flow measure has essentially -- we stopped taking out a number of adjustments and really streamline it to a point where it's operating cash flows less investing activities and only adjusting for extraordinary items like the 3T settlements.

Damien McDonald -- Chief Executive Officer

I mean, largely in response to a number of discussions we had with people and about clarifying and not sort of exceptionalising and I think this is a much more robust definition. Year-on-year it creates some muddiness, but I think we are at a place now where our cash flow is much more robust and I think what you could calculate directly from GAAP.

Scott Bardo -- Berenberg -- Analyst

Okay good. Very quickly then, and I guess the underlying nature of that question was clearly then you're still seeing some material adjustments this year. When do we get a cleanness out of free cash flow. I mean, do you expect some of these adjustments to significantly abide next year. Can you give us some sense of that?

Alex Shvartsburg -- Interim Chief Financial Officer

I think for the most part, we've seen a lot of these adjustments coming out even in the latter part of 2020. So...

Damien McDonald -- Chief Executive Officer

Again I think we will look at that table and the chart, where you can see there that there is significant differences in a number of the metrics there. And I think that again I hope provides a lot of clarity to people is that we're modeling what we were taking out and also going forward, I think you can expect lower merger and integration costs, those sorts of things that have been in a pretty high for a number of years.

Scott Bardo -- Berenberg -- Analyst

All right, thanks guys. I'll jump back in the queue.

Alex Shvartsburg -- Interim Chief Financial Officer

Thanks Scott.

Damien McDonald -- Chief Executive Officer

Thanks, Scott.

Operator

Thank you. Our next question comes from Matt Taylor with UBS. Your line is open.

Matt Taylor -- UBS -- Analyst

Good morning. Thanks for taking the question. So I wanted to follow-up on an earlier question about assumptions behind the guidance and just see if you could give us some flavor or color on how conservative you think the guidance is with regards to recovery assumptions through the year in some of the different businesses? Have you baked in some haircut. And what does it assume in terms of overall utilization recovery?

Alex Shvartsburg -- Interim Chief Financial Officer

So, I mean in terms of the overall forecast, we think it's appropriate. Given the current COVID situation, we still -- there's still a lot of uncertainty. We're seeing that continue to read through in the first quarter. So we're thinking about the sales forecast in terms of showing glimpses of recovery in the second half. So we -- we're still modeling essentially a depressed market.

Damien McDonald -- Chief Executive Officer

Yes, so Q1 is the toughest comp and then we gradually see progression throughout the year. I think I used the word cautiously optimistic as procedures grow, the vaccine rollout continues and patients feel willing to go back, a number of our disease states require willingness of patients to reenter the clinics like Epilepsy which skews pediatric, right. So this 30% of our patients are pediatric and you need to carer and the child to go into the clinic. So I think we're in a very cautious on Q1 with a gradual improvement throughout the rest of the year.

Matthew Dodds -- Senior Vice President, Corporate Development

And the last thing I'd say Matt is on neuromod epilepsy, in general. That's the one that gets a lot of attention. We're forecasting, is that for NPI the funnel has been delayed, not backlog. So it's just been kind of a lag on that, but for replacement of end-of-service, we do think there's going to be an OR backlog, so we're going to recapture patients in 2021, but we've been modeled some of them end up in 2022.

Matt Taylor -- UBS -- Analyst

Okay, thanks. Thanks, Matt and Damien. So one follow-up on Epilepsy. I think everything you said about the impacts here in the last couple of quarters is really been around COVID. I was curious, are you seeing any drug headwinds or impact from recalls or anything else that is hampering that business?

Matthew Dodds -- Senior Vice President, Corporate Development

No, we included in our modeling the impact of drugs. We continue to monitor all of that very closely. We're not seeing specific headwinds in any specific geography for any drug impact.

Matt Taylor -- UBS -- Analyst

Okay. And sorry, just one more follow-up. I want to be really explicit about this, because I got a little confused by the comments. When you're giving this EPS guidance in the points 165. So that includes Heart Valve this year. So basically you're saying if you do divest it in the second quarter we should take out a prorated amount of $0.10 to $0.15, so basically your underlying guidance midpoint is below the 165?

Alex Shvartsburg -- Interim Chief Financial Officer

That is correct.

Matt Taylor -- UBS -- Analyst

Okay, super. Thank you very much.

Damien McDonald -- Chief Executive Officer

Thanks, Matt. Cheers.

Operator

Thank you. Our next question comes from Mike Matson with Needham. Your line is open.

David -- Needham -- Analyst

Yes, thanks, good morning everyone. This is David on for Mike. Thanks for taking our questions.

Damien McDonald -- Chief Executive Officer

Hi, David.

David -- Needham -- Analyst

Just a question. Yes, hey guys. You listed some cost containment measures you're taking on hiring freeze, executive comp, etc. Did you make any cuts to the sales force across any of the businesses and with these measures continuing into 2021, what gives you confidence that it's not going to impact the growth profile over, call it the next 12 to 18 months?

Damien McDonald -- Chief Executive Officer

Yes, good question. No, we didn't cut the sales force, that's not where headcount freezes have occurred. And going into 2021 we're actually increasing headcount slightly in those areas. ACS for example we've talked about hiring 20 additional people into the ACS team in the US. We've already started that in Q4 and that will continue through the next couple of quarters. And similarly in Epilepsy the pod [Phonetic] teams, we committed to hiring at least another three of those in the year-end, we started recruiting for that. So the sales organization is not been impacted by this.

David -- Needham -- Analyst

Okay, thank you. And then just a question on the balance sheet. I think you said you had just over $500 million net debt and you'll get some cash from the sale of Heart Valves. So how are you thinking about the balance sheet and then if I could sneak one more. And you talked about a backlog of VNS replacements. It seems like you guys could probably have some visibility into that. So could you quantify that backlog? Thanks so much.

Alex Shvartsburg -- Interim Chief Financial Officer

So from a balance sheet perspective, that's correct. We ended 2020 with $250 million roughly, in cash. We are -- obviously we've stated this before, kind of in a cash preservation mode at this point in time. So there is no plans for any major capital deployment initiatives other than the normal investments behind based business and capex.

Matthew Dodds -- Senior Vice President, Corporate Development

And then for the US backlog, it's not perfect maths, but we are estimating that today there is about a 1,000 to 1,500 patients in the US who should have already come back for the replacement. And again, as we talked about before, we have a pretty high capture rate on replacement. So nothing has changed to suggest they are not coming back. It's more a matter of timing and as we've said, you can wait at least six months, maybe a little longer to have your battery replaced, but we're seeing some of the people that held off in 2020 in the first half of the year, kind of April, May, June were coming back. So we feel pretty confident in that number.

David -- Needham -- Analyst

Great, thank you.

Damien McDonald -- Chief Executive Officer

Thanks David.

Operator

Thank you. There are no further questions in the queue. I'd like to turn the call back to Damien for any closing remarks.

Damien McDonald -- Chief Executive Officer

Well, thank you Catherine. Thank you everyone for joining us. We look forward to updating you on our Q1 call in a couple of months. And I just want to thank all of the team globally for their continued passion for our business. And thank you for your interest in our company. Bye.

Operator

[Operator Closing Remarks]

Duration: 49 minutes

Call participants:

Matthew Dodds -- Senior Vice President, Corporate Development

Damien McDonald -- Chief Executive Officer

Alex Shvartsburg -- Interim Chief Financial Officer

Rick Wise -- Stifel -- Analyst

Anthony Petrone -- Jefferies -- Analyst

Adam Maeder -- Piper Sandler -- Analyst

Michael Polark -- Robert W. Baird -- Analyst

Scott Bardo -- Berenberg -- Analyst

Matt Taylor -- UBS -- Analyst

David -- Needham -- Analyst

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