CNXN Q3 Deep Dive: Cloud, Cybersecurity Margins Offset Public Sector Weakness

IT solutions provider Connection (NASDAQ:CNXN) fell short of the markets revenue expectations in Q3 CY2025, with sales falling 2.2% year on year to $709.1 million. Its non-GAAP profit of $0.97 per share was 3.5% below analysts’ consensus estimates.

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StockStory’s Take

Connection’s third quarter saw results below Wall Street’s expectations, with revenue declining due to weaker public sector sales. Management attributed the shortfall primarily to delayed federal projects and funding uncertainty at various government levels. CEO Timothy McGrath emphasized the company’s ability to grow gross profit and expand margins by focusing on higher-value segments such as cloud software, cybersecurity, and services. While the public sector posed challenges, Connection’s Business Solutions and Enterprise Solutions segments reported resilient demand, especially in cloud and advanced technologies.

Looking ahead, management sees growth opportunities as customers modernize IT infrastructure, particularly in AI, data center modernization, and cloud adoption. McGrath highlighted a strong enterprise pipeline and ongoing investments in technical services to support client migrations and digital transformation. However, he cautioned that public sector funding cycles remain unpredictable, which could impact quarterly results. CFO Thomas Baker added that while gross margins may stay flat year-over-year, expense discipline and a healthy backlog position Connection for steady performance as it moves into 2026.

Key Insights from Management’s Remarks

Management cited strong execution in cloud and cybersecurity, while public sector budgets and delayed federal projects led to a year-on-year revenue decline.

• Cloud and cybersecurity growth: Connection achieved record gross margins, driven by higher-value sales in cloud software, cybersecurity, and recurring services, which are recognized on a net revenue basis and helped offset top-line pressures.
• Public sector headwinds: The Public Sector Solutions segment saw decreased sales due to delayed federal projects and uncertainty in government funding cycles, but gross margin in this segment improved as the mix shifted toward higher-margin offerings.
• Enterprise and business momentum: Both Enterprise and Business Solutions segments experienced gross profit growth, with enterprise clients investing in AI infrastructure, data center modernization, and endpoint devices. These verticals contributed to a backlog at its highest level in nearly two years.
• Retail and financial services strength: Retail and financial services verticals posted double-digit net sales and gross profit growth as customers prioritized digital transformation and system upgrades, turning to Connection for tailored solutions.
• Expense and headcount discipline: Despite higher personnel-related costs, Connection reduced overall headcount by nearly 3%, maintaining payroll costs flat and protecting operating margins even as SG&A rose as a percentage of sales.

Drivers of Future Performance

Management expects continued growth in cloud, data center, and AI-driven services, but public sector recovery and evolving IT spending patterns remain key variables.

• Enterprise and cloud investment: Management sees sustained demand among enterprise clients for data center consolidation, cloud migration, and AI infrastructure, supported by a robust backlog and ongoing customer interest in modernizing legacy systems.
• Public sector uncertainty: The timing of government funding and project approvals is a major wildcard for near-term results. Management noted that federal shutdowns and delayed project deliveries could continue to weigh on public sector segment performance.
• Margin and expense dynamics: CFO Thomas Baker expects gross margins to remain flat year-on-year, with operating expenses potentially rising due to revenue mix and investment in service capabilities. Ongoing cost control measures, however, are expected to support profitability as Connection pursues mid-single-digit growth.

Catalysts in Upcoming Quarters

In the coming quarters, our team will monitor (1) the pace at which enterprise and business clients adopt AI, cloud, and data center solutions; (2) signs of recovery in public sector spending as government funding cycles normalize; and (3) the ability to maintain or improve gross margins amid evolving revenue mix and ongoing investment in technical services. The trajectory of the PC refresh cycle and continued backlog conversion will also be important indicators.

Connection currently trades at $60.88, in line with $60.77 just before the earnings. Is there an opportunity in the stock?See for yourself in our full research report (it’s free for active Edge members).

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