Despite a tough macroeconomic backdrop, software giant Oracle (ORCL -1.20%) produced solid quarterly results when it reported on Monday. Excluding the acquisition of Cerner, revenue grew by 9% year over year at constant currency in the fiscal second quarter of 2023, which ended Nov. 30.

Oracle's cloud business stood out. Total cloud revenue, which includes infrastructure-as-a-service (IaaS) and software-as-a-service (SaaS), soared 48% year over year in constant currency to $3.8 billion. IaaS on its own generated $1 billion in revenue, up 59% year over year.

Making noise in the cloud

Oracle is a small player in the IaaS market, but it's expanding faster than the market leaders. Amazon's AWS grew by 28% at constant currency in the most recent quarter; Microsoft's Azure grew by 42%; and Alphabet's Google Cloud grew by 38%.

Oracle is having success winning over large customers, which has helped drive triple-digit IaaS bookings growth in recent quarters, according to CEO Safra Catz. The company has been aggressively expanding its cloud platform, with 40 public cloud regions in operation and an additional nine currently being built. The company also boasts nine national security regions designed for U.S. government customers.

Oracle scored a huge win last week by being included in a $9 billion cloud contract from the U.S. Department of Defense. Oracle shares that contract with Amazon, Microsoft, and Google -- a notable win for a company that has a much smaller cloud computing business than the market leaders.

Oracle now has 22,000 cloud infrastructure customers, and Chairman Larry Ellison said during the earnings call that the company signed multiple $1 billion cloud infrastructure deals during the second quarter. One big source of these cloud wins is existing customers. The company is seeing organizations running Oracle databases in their own data centers upgrading to its Autonomous Database, which only runs on Oracle's cloud.

Oracle's core database software can be run on other cloud platforms, so it's imperative that the company offers its existing on-premises customers the most attractive path to the cloud with its Autonomous database offering. It appears to be executing effectively on that front.

Growth is expensive

One reason Oracle was able to win that U.S. DOD contract, along with its other large cloud contracts, is the recent expansion of its network of cloud data centers. Growing the cloud footprint has been costly, though, and it's putting pressure on free cash flow.

Oracle has poured nearly $6.7 billion into capital expenditures over the past 12 months, and $2.4 billion in the second quarter alone. The company's trailing-12-month (TTM) capex was just $2.8 billion about 18 months ago, so this is a rapid acceleration of spending. Historically, Oracle spends very little on capex, so it's safe to say that most of this is going toward the cloud business.

As reported, Oracle's TTM free cash flow actually increased a bit on a year-over-year basis. TTM free cash flow was $8.4 billion in the second quarter, up from $7.1 billion a year ago. However, that previous year's result was impacted by a $4.7 billion charge related to litigation. If you add that back, free cash flow is down significantly year over year. Prior to that charge, Oracle's TTM free cash flow was routinely above $12 billion.

There's no question that Oracle's ramped-up cloud spending is taking a big bite out of its free cash flow. That's the price Oracle must pay as it attempts to win market share and grow its cloud business into a market leader. The company's ability to win big cloud contracts, particularly the U.S. DOD contract, is impressive given the relatively small scale of its cloud business.

Investors should be happy with the progress Oracle is making in the cloud, but they should also understand that free cash flow is likely going to be under pressure for years as the company goes after the cloud infrastructure opportunity.