The Domino Effect....

On Monday, before any of the grisly Cisco news came out, Applied Micro issued a two-paragraph statement saying that it saw order "push-outs" (postponements) and outright cancellations last week. While Chairman and Chief Executive Dave Rickey didn't change the guidance provided in his last quarterly conference call, he emphasized that meeting that guidance depends on the amount of orders the company receives and ships during the quarter. Although he said new orders remained "robust," the recent push-outs and cancellations are troubling. "If these cancellations are merely a blip and not a trend at AMCC, we expect to meet or beat expectations," Rickey said. "However, given concerns that abound in our end markets, we are on alert."

Applied Micro's candor took a 14.5% toll on its stock, but the fallout didn't spread to other chip makers until later in the day, when they too succumbed to the malaise. Last month when PMC warned of weaker earnings and revenue in its fourth-quarter report, other communications-chip makers were barely nicked, but PMC got hit hard enough for everyone. Wall Street, which was focusing on slowing order rates and a weak outlook, shaved 23% from PMC shares in one day, leaving it at $74, or 71% off its 52-week high of $255.50.

And it was plenty clear that there was trouble brewing for the chip makers at Cisco long before the latest numbers. The networker raised a red flag in its fiscal first-quarter report (released on Nov. 6) when it showed a 335% sequential increase in chip inventory. A buildup that big could only mean one thing — that Cisco's suppliers would probably see a slowdown in orders.

By and large, they have. PMC, which draws an estimated 40% of its revenues from Cisco and Lucent Technologies (LU), reported that fourth-quarter orders slowed across the board. What's more, first-quarter revenue is expected to fall about 30% sequentially. As for Broadcom (BRCM), despite an impressive fourth quarter marked by strong sales to 3Com (COMS), sales to Cisco were light. And now, Applied Micro is seeing some softness as well.

Adding to the chip makers' concerns is the fear that the worst of the inventory correction may not be over. To get a better handle on how long this softness will last, many analysts were looking to Cisco's conference call for some direction. But with inventory once again spiking and expected to increase again sequentially, it's going to take some time for Cisco to get a handle on its inventory situation. What's more, the company's guidance is pretty conservative. On the top line, managment is expecing sequential revenue to be flat to down 5% in the third quarter, with the fourth quarter flat with the third.

Of course, there are still plenty of unknowns in the telecom sector. But one thing is clear: If Cisco is seeing a slowdown, the reverberations will be felt across the board.