Red Hat (NYSE: RHT), a software business whose colleagues include Microsoft (NASDAQ: MSFT) and Oracle (NASDAQ: ORCL), reported Q2 numbers yesterday after the bell. Today, shares are up quite spectacularly. What's driving all the buying interest?

Well, the results were worthy of praise. Net sales increased 12%. Subscriptions were higher by 15%. Adjusted income, including the elimination of a tax benefit from the total, was 16 cents per share. According to Earnings.com, the market was looking for 15 cents per share. So, we've got the typical beat-by-a-proverbial-penny situation on our hands. I'd rather it be more than a penny, but I'll take it.

It's far from easy selling enterprise software today. But some companies are finding ways to grow. Just look at Red Hat (NYSE: RHT), which is a leader in open source solutions.

The company's applications, which help to reduce costs and increase productivity, have shown lots of resilience during the recession. For example, according to Red Hat's latest earnings report, the top 25 deals that were up for renewal got renewed. Actually, theses customers increased the commitments by 120%.

Minyanville Professor Adam Katz dares to share the kind of keen insight and actionable information you won't find in any prospectus. For more original thought, visit www.minyanville.com.

I've said it before: the second quarter is going to be the inverse of the first. Expectations going in were simply too high.

What I find interesting is that Oracle (NASDAQ: ORCL), Red Hat (NYSE: RHT) and Research In Motion (NASDAQ: RIMM) have all taken down guidance due to the sluggishness they're starting to see in their businesses.

What the Street seems to be ignoring is that the dollar has been crushed for over a year now, which means that the currency tailwind is only getting weaker as the year drags on. If one uses $1.55 euro per dollar as a benchmark, the second-quarter effect was a 14% year-over-year currency tailwind.

In the third quarter, that drops to 10%; in the fourth, it will drop to 5%. Add in macroeconomic headwinds -- along with the fact that credit markets have been pushed back into a state of mild panic -- and it's a surefire recipe for a very tumultuous back half of the year.

I'm looking hard for reasons to be optimistic, but they seem to be thin on the ground. In the information technology (IT) sector, at least, we'll likely see a meaningful budget flush at the end of the year - if only because they'll be cut in a big way starting in 2009. This means that IT managers, if they even think they might need anything over the next year or so, need to use or lose whatever's left in their 2008 budgets come the fourth quarter.

This will create an environment where people will be calling the bottom for IT in the fourth quarter - but it's more likely to be the last hurrah before the bottom drops out.

Position in RHT

Red Hat (NYSE: RHT) provides customers with the Linux open source computer operating system. It also provides a variety of compatible technical programs, software development tools, support services and training programs. Microsoft (NASDAQ: MSFT), with its Windows operating system, is Red Hat's chief competitor. The firm operates strategic alliances with Intel (NASDAQ: INTC) and Advanced Micro Devices (NASDAQ: AMD).

Red Hat pleased investors earlier in the month, when it reported fiscal Q3 EPS of 19 cents and revenues of $135.4 million. Analysts had been expecting 18 cents and $132.4 million. A sharp jump in subscriptions more than offset increased operating expenses. Management also provided strong guidance for Q4/FY08 and announced that former Delta Airlines (NYSE: DAL) COO James Whitehurst would take over as CEO on January 1. RHT shares popped on the news and then moved into a bullish "flag" consolidation pattern. Prices frequently exit flags moving in the same direction they were traveling on entry. In this case, that would be to the upside.

Brokers recommend the shares with one "strong buy", six "buys," fourteen "holds" and one "sell." Analysts see a 23% average annual growth rate, through the next five years. The RHT Price to Book ratio (4.27), Price to Free Cash Flow ratio (26.28), Sales Growth rate (27.98%) and EPS Growth rate (171.43%) compare favorably with industry, sector and S&P 500 averages. Institutions own about 95% of the outstanding shares. The stock is one of those used to calculate the AMEX Internet Index. Over the past 52 weeks, it has traded between $18.04 and $25.25. A stop-loss of $18.15 looks good here.

Larry Schutts is a contributing editor for Theflyonthewall.com and the Vice-President of Stockwinners.com. He does not hold positions in any of the stocks mentioned above.

Red Hat Inc. (NYSE: RHT) shares are trading higher this morning the company posted third-quarter earnings of 10 cents per share on revenues of $135.4 million after the close yesterday. Analysts had expected earnings of 10 cents per share on revenues of $132.4 million. RHT also raised its fiscal 2008 revenue outlook to between $521 million to $523 million, up from $510 million to $520 million. If you think that the company won't fall by too much in the coming months, then now could be a good time to look at a bullish hedged trade on RHT.

After hitting a one-year low of $17.96 last December, the stock hit a one-year high of $25.25 in June. RHT opened this morning at $20.17. So far today the stock has hit a low of $20.00 and a high of $20.68. As of 11:30, RHT is trading at $20.66, up $1.87 (9.9%). The chart for RHT looks bearish and steady, while S&P gives the stock a neutral 3 STARS (out of 5) Hold rating.

For a bullish hedged play on this stock, I would consider a March bull-put credit spread below the $17.50 range. A bull-put credit spread is an options position that combines the purchase and sale of put options to hedge risk in case the stock doesn't do what you think but still leverage nice returns. For this particular trade, we will make an 8.7% return in just 3 months as long as RHT is above $17.50 at March expiration. Red Hat would have to fall by more than 15% before we would start to lose money.

RHT hasn't been below 17.50 in over a yeat, and could lose up to 14.9% before this trade loses money.

Brent Archer is an options analyst and writer at Investors Observer. At publication time, Brent neither owns nor controls positions in RHT.

LDK Solar (NYSE: LDK) is up 16% on news of a new contract with Q-Cells.

Novavax (NASDAQ: NVAX) is trading up 12% on a partnership with GE (NYSE: GE)'s healthcare group.

Hemispherx Biopharma (AMEX: HEB) is off 20% on a terminated license agreement with Esteve.

Red Hat (NYSE: RHT) is moving down almost 4% on a downgrade from Jefferies & Co.

Stocks may trade differently in the pre-market than they do in the regular session.

Douglas A. McIntyre is an editor at 247wallst.com.

MOST NOTEWORTHY: Rockwell Automation, Barclays, F5 Networks, Foundry Networks, AMR Corp., and Red Hat were today's noteworthy downgrades:

• JP Morgan downgraded Rockwell Automation Inc (NYSE: ROK) to Neutral from Overweight based on valuation, as the firm believes the recent credit market turbulence could make a material recapitalization less likely.
  
• Bear Stearns downgraded shares of Barclays (NYSE: BCS) to Underperform from Peer Perform on valuation and expectations for losses in the company's Capital division.
  
• Nollenberger downgraded shares of F5 Networks Inc (NASDAQ: FFIV) to Neutral from Buy, as they believe the company is transitioning from a "beat and raise" story to a "meet and maintain" story given the recent disruptions in the financial services sector and slowing growth in active web hosts on the net. The firm also downgraded shares of Foundry Networks Inc (NASDAQ: FDRY) to Neutral from Buy on valuation, seeing a well balanced risk/reward profile at current levels.
  
• Soleil downgraded shares of AMR Corporation (NYSE: AMR) to Hold from Buy to reflect the company's deteriorating revenue and non-fuel cost outlook.
  
• Red Hat Inc (NYSE: RHT) was downgraded to Neutral from Outperform at Credit Suisse, citing lack of progress in execution.

OTHER DOWNGRADES:

• LDK Solar (NYSE: LDK) was downgraded at CIBC to Sector Performer from Outperformer.
  
• Friedman Billings downgraded Parker Hannifin Corporation (NYSE: PH) to Market Perform from Outperform.
  
• Morgan Keegan downgraded Cree Inc (NASDAQ: CREE) to Market Perform from Outperform.

The theory goes that Linux, the open-source operating system, will replace Windows as the preferred software to run servers. Over time, the cost advantage of software created by a community of developers would overwhelm the pricey Microsoft (NASDAQ: MSFT) product.

So much for theory. Windows is actually taking share from Linux in the server market. According to TheStreet.com "Microsoft picked up 2 percentage points, bringing its market share to 67.1% of servers shipped during the second quarter." Windows server revenue hit $5 billion in the second quarter compared to $1.8 billion for Linux.

The one operating system that did not do well in the last quarter was Unix, which is marketed by Sun (NASDAQ: JAVA) among others.

In some ways the figures are not a surprise, despite the cost advantage of Linux. The large enterprise marketers of the software, Novell (NASDAQ: NOVL) and Redhat (NASDAQ: RHT) have never become large companies.

Linux still operates under the threat of patent litigation. Microsoft has claimed that the open-source software violates several hundred of its patents.

Big enterprises shy away from products with potential IP problems, and that may be Microsoft's biggest weapon.

Douglas A. McIntyre is a partner at 24/7 Wall St.

Computerworld.com has reported that Red Hat (NYSE: RHT) set the release for their newly unveiled Global Desktop for some time in June 2007. The operating system which was jointly developed with Intel Corp. (NASDAQ: INTC), appears to be aimed at small business and local government users with the additional undertones of a desire to be the enabling operating system of choice for developing industrial nations.

Red Hat CTO Brian Stevens indicates that the company seeks to provide an operating system that can be more closely tuned to the individual customers needs. He is quoted at OSDir.com as stating: "Users, requirements and technologies have changed so dramatically over the past few years that the traditional one-size-fits-all desktop paradigm is simply exhausted."

MOST NOTEWORTHY: Visicu, Inc (EICU), Ciena Corp (CIEN), Apple Inc (AAPL) and Time Warner Cable (TWC) were some of today's more notable initiations:

• Prudential started Visicu Inc (NASDAQ: EICU) with an Underweight rating and $7 target and said competitor substitute ICU modules, hesitant customers and patent challenges could impact future sales activity.

• RBC initiated Ciena Corp (NASDAQ: CIEN) with an Outperform rating and $33 target based on improving demand outlook driven by growth in video and data-traffic.

• W.R. Hambrecht initiated shares of Apple Inc (NASDAQ: AAPL) with a Buy rating and $110 target based on the company's impressive desktop and notebook offering that continues to grow faster than the industry and command higher ASPs, an iPod franchise that dominates the category and represented almost half of total company revenues in the strongest quarter in its history, December 2006, among other things.

• Deutsche Bank initiated Time Warner Cable (NYSE: TWC) with a Buy rating and $46 target. The firm is bullish on cable sector prospects and sees upside from consumer and commercial telecom services and growth in advanced video services.

OTHER INITIATIONS:

• RBC started F5 Networks, Inc (NASDAQ: FFIV) with an Outperform rating and $90 target.

• Stanford initiated HealthSouth Corp (NYSE: HLS) with a Buy rating and $31 target.

• Kenexa Corp (NASDAQ: KNXA) was started at Jefferies with a Hold rating and $36 target.

• Stern Agee initiated Chico's FAS, Inc (NYSE: CHS) with a Buy rating and $26 target.

• JP Morgan initiated Red Hat, Inc (NYSE: RHT) with a Neutral rating.

Analyst summaries provided by TheFlyOnTheWall.com (subscription required).

MOST NOTEWORTHY: Research in Motion (RIMM) and Micron (MU) were the most noteworthy upgrades this morning:

• Bear Stearns upgraded shares of Research in Motion Ltd. (NASDAQ:RIMM) to Outperform from Peer Perform, telling clients it sees further upside from new handset launches and continued expansion.
• First Albany upgraded shares of Micron Technology Inc. (NYSE:MU) to Buy from Neutral following the company's first-quarter report; the firm told clients that a weak first-half of 2007 has already priced into the shares but a strong second-half of 2007 has not.

OTHER UPGRADES:

• RBC Capital upgraded shares of Chipotle Mexican Grill Inc. (NYSE:CMG) to Outperform from Underperform, citing continued strong fundamentals and expectations that the company can meet or slightly beat first-quarter comp-store sales estimates.
• Red Hat Inc. (NYSE:RHT) was upgraded to Buy from Neutral at First Albany; the firm told clients that the company's Q3 report validates its thesis that the impact from Oracle Corp. (NASDAQ:ORCL) will be minimal, continued growth in RHEL deployments is likely, and pricing power is sustainable. Red hat was also upgraded by Citigroup to Hold from Sell and raised the target to $21 from $13.50.

Analyst summaries provided by TheFlyOnTheWall.com (subscription required).

Red Hat Inc. (NYSE:RHT) was supposed to be on its way out. The largest supplier of Linux open source products to corporations was going to be crushed by rival Novell Inc. (NASDAQ:NOVL) after it signed a deal with Microsoft Corp. (NASDAQ:MSFT) to jointly market Linux and Windows. Open source programmers were upset by the deal, but Microsoft is prepared to put up hundreds of millions of dollars to support it.

Well, perhaps large corporations that want open source operating systems also want to avoid a Microsoft-funded venture. Fox in the chicken house.

Red Hat revenue took off in the last quarter. Red Hat added 12,000 new customers in the quarter and revenue was up 45% to $108 million.

The stock, which fell to under $14 on the Novell/Microsoft tie up hit over $20 after hours.

Microsoft's attempt to move into the world of Linux is not looking very good now.

Douglas A. McIntyre is a partner at 24/7 Wall St.

Stock futures were positive in early morning trade, indicating to a similar start for stocks.

Today several economic indicators will be released:
- At 8:30 a.m. Eastern, weekly initial jobless claims and final GDP number for the third quarter are due. Economists are expecting a 2.2% economic growth, same as the previous quarter.
- At 10:00 a.m., November leading indicators will be reported. Consensus calls for a 0.1% increase, compared to 0.2% the month before.
- At noon, Philadelphia Fed index will be released.
- At 1:00 p.m., Richmond Fed President Jeffrey Lacker, the only Federal Open Market Committee member who voted for a rate hike, is due to speak.

In earnings news:
Nike Inc. (NYSE:NKE) reported quarterly earnings late yesterday. A tax break from the Dutch, surging demand in China and the success of converse, helped the world's largest athletic shoe and clothing company boost profit in its second quarter to $325.6 million, or $1.28 per share, from $301.1 million, or $1.14 per share, during the same period last year. Sales increased 10% to $3.82 billion. NKE shares were down 1.5% in after hours trading.

Also yesterday, Bed Bath & Beyond Inc. (NASDAQ:BBBY) posted a third-quarter profit rise of 3.8% as sales increased to $142.4 million, or 50 cents per share. Analysts expected profit of 52 cents per share. The company expects a fourth-quarter charge related to stock option grants. BBBY shares were down nearly 3% in after hours trading.

Reporting today:

In corporate news:
The unsecured creditors committee for Delta Air Lines said it supports Delta's decision to file its stand-alone reorganization plan, but that it also will weigh alternatives. So far the committee hadn't reacted much to US Airways Group's (NYSE:LCC) unsolicited $8.4 billion bid for Delta.

Sun Microsystems, Inc. (NASDAQ:SUNW) has decided to make its software platform, Java, open source, not unlike the Linux OS that is marketed by Novell and Red Hat, Inc. (NASDAQ:RHAT). Microsoft Corp. (NASDAQ:MSFT) recently teamed with Novell, Inc. (NASDAQ:NOVL) to distribute Windows with the Suse version of Linux.

Sun's argument for making Java open source is that it will be more attractive to customers and programmers. But, being free does not always drive adoption. There is a reason that Microsoft still owns the operating system business worldwide while Linux is free. Without a development path lead by one company, the software can be hard to manage.

One thing for certain is that the market does not care. Sun's stock was up 1% on the news. The stock has been trading in a narrow range just above $5 for the last two months.

Microsoft Corp. (NASDAQ:MSFT) has not paid out this kind of money unless the company was settling a patent claim or antitrust judgment. The company is investing $400 million in its partnership with Novell [subscription required]. The partnership, announced last week, aims to get the Windows and Linux operating systems working nicely together on PCs.

MSFT will be paying for coupons so that corporate customers can get annual licenses to the Suse Linux operating system. It is, in essence, paying for the distribution of the open source software it has feared would take market share from Windows.

With Microsoft's new operating system, Vista, about to launch, supporting rival Linux would seem a queer thing to do.

Not necessarily. If Microsoft becomes the de facto largest reseller of Linux, it will have some measure of control over how fast the open source initiative can grow. Novell, Inc.'s (NASDAQ:NOVL) annual sales are under $1.2 billion, and its rival in the Linux market, RedHat, Inc. (NASDAQ:RHAT) has sales of well under $300 million.

Microsoft also got a promise from Novell that it would not sue Microsoft over Windows, presumably over any patent issues or monopoly practices.

And that, by itself, could be worth $400 million.

Douglas McIntyre is a partner at 24/7 Wall St.