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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





Form 10-Q







|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2009

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission file number: 001-33778





NEUTRAL TANDEM, INC.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|Delaware                                                       |  | 31-1786871                       
|(State or other Jurisdiction of Incorporation or Organization) |  | (IRS Employer Identification No.)

One South Wacker Drive

Suite 200

Chicago, IL 60606

(Address of principal executive offices, including zip code)

(312) 384-8000

(Registrants telephone number,
including area code)





Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No   ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definition of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈                                                |  | Accelerated filer         |  | x
|                        |  |                                                  | 
|Non-accelerated filer   |  |  ̈  (Do not check if a smaller reporting company) |  | smaller reporting company |  |  ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).    Yes   ̈    No  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files).    Yes   ̈    No   ̈

As of November 1, 2009, 33,549,381 shares of the registrants Common Stock, $0.001 par value, were issued and outstanding.









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NEUTRAL TANDEM, INC.

INDEX



|                              |  |                                                                                                                     |  |     
|----------------------------- |  | ------------------------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                                     |  | Page
|PART I. FINANCIAL INFORMATION
|                              |  |                                                                                                                    
|Item 1.                       |  | Condensed Consolidated Financial Statements                                                                         |  | 3   
|                              |  |                                                                                                                    
|                              |  | Condensed Consolidated Balance Sheets  September 30, 2009 and December 31, 2008                                    |  | 3   
|                              |  |                                                                                                                    
|                              |  | Condensed Consolidated Statements of Income  Three and nine months ended September 30, 2009 and September 30, 2008 |  | 4   
|                              |  |                                                                                                                    
|                              |  | Condensed Consolidated Statements of Cash Flows  Nine months ended September 30, 2009 and September 30, 2008       |  | 5   
|                              |  |                                                                                                                    
|                              |  | Notes to Condensed Consolidated Financial Statements                                                                |  | 6   
|                              |  |                                                                                                                    
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                               |  | 15  
|                              |  |                                                                                                                    
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risk                                                          |  | 21  
|                              |  |                                                                                                                    
|Item 4.                       |  | Controls and Procedures                                                                                             |  | 22  
|                             
|PART II. OTHER INFORMATION   
|                              |  |                                                                                                                    
|Item 1.                       |  | Legal Proceedings                                                                                                   |  | 22  
|                              |  |                                                                                                                    
|Item 1A.                      |  | Risk Factors                                                                                                        |  | 22  
|                              |  |                                                                                                                    
|Item 6.                       |  | Exhibits                                                                                                            |  | 25  



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PART I. FINANCIAL INFORMATION



|Item 1. | Condensed Consolidated Financial Statements (Unaudited)
|------- | -------------------------------------------------------

NEUTRAL TANDEM, INC. AND SUBSIDIARIES

CONDENSED
CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(Unaudited)



|                                                                                                                                                                                         |  |                   |         |                  |   |        
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | ---------------- | - | -------
|                                                                                                                                                                                         |  | September 30,2009 |         | December 31,2008
|ASSETS                                                                                                                                                                                   |  |                   |         |                  |   |        
|Current assets:                                                                                                                                                                          |  |                   |         |                  |   |        
|Cash and cash equivalents                                                                                                                                                                |  | $                 | 158,231 |                  | $ | 110,414
|Receivables                                                                                                                                                                              |  |                   | 22,029  |                  |   | 16,785 
|Deferred tax asset-current                                                                                                                                                               |  |                   | 3,395   |                  |   | 2,341  
|Other current assets                                                                                                                                                                     |  |                   | 17,636  |                  |   | 1,795  
|                                                                                                                                                                                         |  |                   |         |                  |   |        
|                                                                                                                                                                                         |  |                  
|Total current assets                                                                                                                                                                     |  |                   | 201,291 |                  |   | 131,335
|Property and equipmentnet                                                                                                                                                               |  |                   | 45,660  |                  |   | 45,266 
|Restricted cash                                                                                                                                                                          |  |                   | 440     |                  |   | 440    
|Investments and other assets                                                                                                                                                             |  |                   | 510     |                  |   | 18,802 
|                                                                                                                                                                                         |  |                   |         |                  |   |        
|                                                                                                                                                                                         |  |                  
|Total assets                                                                                                                                                                             |  | $                 | 247,901 |                  | $ | 195,843
|                                                                                                                                                                                         |  |                   |         |                  |   |        
|                                                                                                                                                                                         |  |                  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                     |  |                   |         |                  |   |        
|Current liabilities:                                                                                                                                                                     |  |                   |         |                  |   |        
|Accounts payable                                                                                                                                                                         |  | $                 | 2,298   |                  | $ | 258    
|Accrued liabilities:                                                                                                                                                                     |  |                   |         |                  |   |        
|Taxes payable                                                                                                                                                                            |  |                   | 2,076   |                  |   | 657    
|Circuit cost                                                                                                                                                                             |  |                   | 2,651   |                  |   | 3,358  
|Rent                                                                                                                                                                                     |  |                   | 1,104   |                  |   | 1,183  
|Payroll and related items                                                                                                                                                                |  |                   | 3,231   |                  |   | 952    
|Other                                                                                                                                                                                    |  |                   | 3,437   |                  |   | 1,535  
|Current installments of long-term debt                                                                                                                                                   |  |                   | 698     |                  |   | 2,961  
|                                                                                                                                                                                         |  |                   |         |                  |   |        
|                                                                                                                                                                                         |  |                  
|Total current liabilities                                                                                                                                                                |  |                   | 15,495  |                  |   | 10,904 
|Other liabilities                                                                                                                                                                        |  |                   |        |                  |   | 191    
|Deferred tax liability-noncurrent                                                                                                                                                        |  |                   | 5,065   |                  |   | 4,647  
|Long-term debtexcluding current installments                                                                                                                                            |  |                   |        |                  |   | 235    
|                                                                                                                                                                                         |  |                   |         |                  |   |        
|                                                                                                                                                                                         |  |                  
|Total liabilities                                                                                                                                                                        |  |                   | 20,560  |                  |   | 15,977 
|Commitments and contingencies                                                                                                                                                            |  |                   |         |                  |   |        
|Shareholders equity:                                                                                                                                                                    |  |                   |         |                  |   |        
|Preferred stockpar value of $.001; 50,000,000 authorized shares; no shares issued and outstanding at September 30,
2009 and December 31, 2008                                           |  |                   |        |                  |   |       
|Common stockpar value of $.001; 150,000,000 authorized shares; 33,531,681 shares and 32,357,383 shares issued and
outstanding at September 30, 2009 and December 31, 2008, respectively |  |                   | 34      |                  |   | 32     
|Additional paid-in capital                                                                                                                                                               |  |                   | 168,402 |                  |   | 151,733
|Retained earnings                                                                                                                                                                        |  |                   | 58,905  |                  |   | 28,101 
|                                                                                                                                                                                         |  |                   |         |                  |   |        
|                                                                                                                                                                                         |  |                  
|Total shareholders equity                                                                                                                                                               |  |                   | 227,341 |                  |   | 179,866
|                                                                                                                                                                                         |  |                   |         |                  |   |        
|                                                                                                                                                                                         |  |                  
|Total liabilities and shareholders equity                                                                                                                                               |  | $                 | 247,901 |                  | $ | 195,843
|                                                                                                                                                                                         |  |                   |         |                  |   |        

The accompanying notes are an integral part of these condensed consolidated financial
statements.



3



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NEUTRAL TANDEM, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

(Unaudited)



|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|------------------------------------------------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                                               |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                               |  | 2009                            |        |   | 2008                           |   |        | 2009 |  |   | 2008    |  
|Revenue                                                                        |  | $                               | 44,692 |   |                                | $ | 31,154 |      |  | $ | 124,176 |   |  | $ | 85,958 |  
|                                                                               |  |                                 |        |  
|Operating expense:                                                             |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Network and facilities expense (excluding depreciation and amortization)       |  |                                 | 13,093 |   |                                |   | 11,215 |      |  |   | 36,987  |   |  |   | 29,711 |  
|Operations                                                                     |  |                                 | 4,991  |   |                                |   | 4,288  |      |  |   | 14,795  |   |  |   | 12,485 |  
|Sales and marketing                                                            |  |                                 | 467    |   |                                |   | 466    |      |  |   | 1,465   |   |  |   | 1,461  |  
|General and administrative                                                     |  |                                 | 5,375  |   |                                |   | 2,801  |      |  |   | 12,468  |   |  |   | 9,013  |  
|Depreciation and amortization                                                  |  |                                 | 3,506  |   |                                |   | 3,561  |      |  |   | 10,746  |   |  |   | 9,647  |  
|Impairment of fixed assets                                                     |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   | 195    |  
|Gain on disposal of fixed assets                                               |  |                                 | (28    | ) |                                |   |       |      |  |   | (53     | ) |  |   |       |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Total operating expense                                                        |  |                                 | 27,404 |   |                                |   | 22,331 |      |  |   | 76,408  |   |  |   | 62,512 |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Income from operations                                                         |  |                                 | 17,288 |   |                                |   | 8,823  |      |  |   | 47,768  |   |  |   | 23,446 |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Other (income) expense:                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Interest expense, including debt discount of $8, $22, $52 and $73 respectively |  |                                 | 49     |   |                                |   | 208    |      |  |   | 276     |   |  |   | 757    |  
|Interest income                                                                |  |                                 | (159   | ) |                                |   | (870   | )    |  |   | (707    | ) |  |   | (2,567 | )
|Other (income) expense                                                         |  |                                 | (65    | ) |                                |   |       |      |  |   | (306    | ) |  |   | 550    |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Total other (income) expense                                                   |  |                                 | (175   | ) |                                |   | (662   | )    |  |   | (737    | ) |  |   | (1,260 | )
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Income before income taxes                                                     |  |                                 | 17,463 |   |                                |   | 9,485  |      |  |   | 48,505  |   |  |   | 24,706 |  
|Provision for income taxes                                                     |  |                                 | 6,377  |   |                                |   | 3,321  |      |  |   | 17,701  |   |  |   | 8,875  |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Net income                                                                     |  | $                               | 11,086 |   |                                | $ | 6,164  |      |  | $ | 30,804  |   |  | $ | 15,831 |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Net income per share:                                                          |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Basic                                                                          |  | $                               | 0.33   |   |                                | $ | 0.19   |      |  | $ | 0.93    |   |  | $ | 0.50   |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Diluted                                                                        |  | $                               | 0.32   |   |                                | $ | 0.19   |      |  | $ | 0.91    |   |  | $ | 0.48   |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Weighted average number of shares outstanding:                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Basic                                                                          |  |                                 | 33,494 |   |                                |   | 32,009 |      |  |   | 33,017  |   |  |   | 31,626 |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|                                                                               |  |                                 |        |  
|Diluted                                                                        |  |                                 | 34,181 |   |                                |   | 33,312 |      |  |   | 33,849  |   |  |   | 33,190 |  
|                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  

The accompanying notes are an integral part of these condensed consolidated financial
statements.



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NEUTRAL TANDEM, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                  |  |                                |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Nine Months EndedSeptember 30, |        
|                                                                                  |  | 2009                           |         |   | 2008 |  
|Cash Flows From Operating Activities:                                             |  |                                |         |   |      |   |         |  
|Net income                                                                        |  | $                              | 30,804  |   |      | $ | 15,831  |  
|Adjustments to reconcile net cash flows from operating activities:                |  |                                |         |   |      |   |         |  
|Depreciation and amortization                                                     |  |                                | 10,746  |   |      |   | 9,647   |  
|Deferred income taxes                                                             |  |                                | (636    | ) |      |   | 1,408   |  
|Impairment of fixed assets                                                        |  |                                |        |   |      |   | 195     |  
|Gain on disposal of fixed assets                                                  |  |                                | (53     | ) |      |   |        |  
|Non-cash share-based compensation                                                 |  |                                | 3,404   |   |      |   | 2,027   |  
|Amortization of debt discount                                                     |  |                                | 52      |   |      |   | 73      |  
|Changes in fair value of ARS                                                      |  |                                | (887    | ) |      |   |        |  
|Changes in fair value of ARS Rights                                               |  |                                | 581     |   |      |   |        |  
|Excess tax benefit associated with stock option exercise                          |  |                                | (9,013  | ) |      |   | (6,492  | )
|Changes in assets and liabilities:                                                |  |                                |         |   |      |   |         |  
|Receivables                                                                       |  |                                | (5,244  | ) |      |   | 1,887   |  
|Other current assets                                                              |  |                                | 1,159   |   |      |   | (374    | )
|Other noncurrent assets                                                           |  |                                | 48      |   |      |   | 229     |  
|Accounts payable                                                                  |  |                                | 757     |   |      |   | 1,175   |  
|Accrued liabilities                                                               |  |                                | 13,636  |   |      |   | (1,347  | )
|Noncurrent liabilities                                                            |  |                                |        |   |      |   | 43      |  
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Net cash flows from operating activities                                          |  |                                | 45,354  |   |      |   | 24,302  |  
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Cash Flows From Investing Activities:                                             |  |                                |         |   |      |   |         |  
|Purchase of equipment                                                             |  |                                | (9,859  | ) |      |   | (14,480 | )
|Proceeds from sale of equipment                                                   |  |                                | 55      |   |      |   |        |  
|Purchase of long-term investments                                                 |  |                                |        |   |      |   | (25,150 | )
|Sale of ARS                                                                       |  |                                | 1,550   |   |      |   | 5,550   |  
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Net cash flows from investing activities                                          |  |                                | (8,254  | ) |      |   | (34,080 | )
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Cash Flows From Financing Activities:                                             |  |                                |         |   |      |   |         |  
|Proceeds from the issuance of common shares associated with stock option exercise |  |                                | 4,254   |   |      |   | 996     |  
|Excess tax benefit associated with stock option exercise                          |  |                                | 9,013   |   |      |   | 6,492   |  
|Principal payments on long-term debt                                              |  |                                | (2,550  | ) |      |   | (3,450  | )
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Net cash flows from financing activities                                          |  |                                | 10,717  |   |      |   | 4,038   |  
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Net Increase (Decrease) In Cash And Cash Equivalents                              |  |                                | 47,817  |   |      |   | (5,740  | )
|Cash And Cash EquivalentsBeginning                                               |  |                                | 110,414 |   |      |   | 112,020 |  
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Cash And Cash EquivalentsEnd                                                     |  | $                              | 158,231 |   |      | $ | 106,280 |  
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Supplemental Disclosure Of Cash Flow Information:                                 |  |                                |         |   |      |   |         |  
|Cash paid for interest                                                            |  | $                              | 624     |   |      | $ | 675     |  
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Cash paid for taxes                                                               |  | $                              | 7,656   |   |      | $ | 3,201   |  
|                                                                                  |  |                                |         |   |      |   |         |  
|                                                                                  |  |                               
|Supplemental Disclosure Of Noncash Flow Items:                                    |  |                                |         |   |      |   |         |  
|Investing ActivityAccrued purchases of equipment                                 |  | $                              | 1,454   |   |      | $ | 985     |  
|                                                                                  |  |                                |         |   |      |   |         |  

The accompanying notes are an integral part of these condensed consolidated financial
statements.



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NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. DESCRIPTION OF THE BUSINESS

Neutral Tandem, Inc. (the Company) provides tandem interconnection services principally to competitive carriers, including wireless,
wireline, cable and broadband telephony companies. Competitive carriers use tandem switches to interconnect and exchange local and long distance traffic between their networks without the need to establish direct switch-to-switch connections. Prior
to the introduction of the Companys service, the primary method for competitive carriers to exchange traffic indirectly was through the use of the incumbent local exchange carriers, or ILECs, tandem switches. The tandem switching
services offered by ILECs consist of transit services, which are provided in connection with local calls, and access services, which are provided in connection with long distance calls. Under certain interpretations of the Telecommunications Act of
1996 and implementing regulations, ILECs are required to provide tandem transit services to competitive carriers. ILECs generally set per minute rates and other charges for tandem transit services according to rate schedules approved by state public
utility commissions, although the methodology used to review these rate schedules varies from state to state. ILECs are also required to offer access services to competing telecommunications carriers under the Telecommunications Act of 1996 and
implementing regulations. ILECs generally set per minute rates and other charges for access services according to mandated rate schedules set by the Federal Communications Commission, or FCC, for interstate calls and by state public utility
commissions for intrastate calls. The Companys services enable competitive carriers to exchange traffic between their networks without using an ILEC tandem for both local and long distance calls.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and
transactions have been eliminated in consolidation.

Interim Condensed Consolidated Financial Statements
The accompanying condensed consolidated balance sheets as of September 30, 2009 and December 31, 2008, the condensed consolidated statements of income for the three and nine months ended September 30, 2009 and 2008, and the
condensed consolidated statements of cash flows for the nine months ended September 30, 2009 and 2008 are unaudited. The condensed consolidated balance sheet data as of December 31, 2008 was derived from the audited consolidated financial
statements which are included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2008. The accompanying statements should be read in conjunction with the audited consolidated financial statements and related
notes contained in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (GAAP) pursuant to the rules and regulations of the Securities and Exchange Commission
applicable to interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant
to such rules and regulations.

In the opinion of management, the unaudited interim condensed consolidated financial
statements as of September 30, 2009 and for the three and nine months ended September 30, 2009 and 2008 have been prepared on the same basis as the audited consolidated statements and reflect all adjustments, which are normal recurring
adjustments, necessary for the fair presentation of its statement of financial position, results of operations and cash flows. The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of
the operating results for any subsequent quarter, for the full fiscal year or any future periods.

Cash and Cash
Equivalents The Company considers all highly liquid investments with an original maturity of 90 days or less to be cash and cash equivalents.

Short-term Investments  The Company considers all investments with remaining time to maturity of one year or less to be short-term investments. At September 30, 2009, the
Companys short-term investments consisted of $17.3 million (par value) of auction rate securities (ARS) recorded within the other current asset category of the Companys condensed consolidated balance sheet. See note 7 to the condensed
consolidated financial statements for further details on the Companys ARS and related ARS Rights.

The Companys
ARS Rights are required to be recognized as a free-standing asset, separate from the Companys ARS. Upon entering into a settlement agreement with UBS in the fourth quarter of 2008, the Company elected to treat the ARS as trading
securities and elected to measure the ARS Rights at fair value. As such, in the third quarter of 2009, the Company recorded a loss of $0.1 million related to the ARS Rights and a gain of $0.2 million on the Companys ARS portfolio related to
the change in fair value during the three months ended September 30, 2009. In the nine months ended September 30, 2009, the loss was $0.6 million related to the ARS Rights and a gain of $0.9 million on the Companys ARS portfolio
related to the change in fair value during the nine months ended September 30, 2009. These amounts are reflected within other (income) expense in the Companys condensed consolidated statements of income.



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NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



The Company may not hold these securities until final maturity because of UBSs
right to purchase and or right to sell the ARS. Changes in the estimated fair value of the ARS and the ARS Rights will be recognized on a quarterly basis until the sale of these securities has been completed.

Fair Values of Financial Instruments The types of instruments valued based on quoted market prices in active markets
include the Companys money market funds. The types of instruments valued based on unobservable inputs in which there is little or no market data, which require the Company to develop its own assumptions, include the Companys ARS and
related ARS Rights. See Note 7 to the condensed consolidated financial statements for further details on investment and fair value measurements.

The Company has not elected to measure its debt at fair value under the Financial Account Standards Board (FASB) Accounting Standards Codification (ASC) section 825-10-50, Financial Instruments:
Disclosure (formerly FASB Staff Position (FSP) N. 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments). The estimated fair value of the Companys debt at September 30, 2009 was $1.0 million compared to the
carrying value of $0.7 million. The Companys estimated fair value of its debt is determined by discounting the future cash flows using a discount rate of approximately 15.0%. This discount rate includes the final interest payment which is
required at the end of the loan term. The carrying amounts of our cash and equivalents, receivables and accounts payable approximate fair value.

The Company applies a discounted cash flow model approach to value its financial assets and liabilities, which include its ARS and ARS Rights. The discounted cash flow model approach takes into
consideration the anticipated coupon rate for the securities, a market-based discount rate, an illiquidity premium and an anticipated workout period, or likely timeframe to redemption or liquidation in the open market. The fair value disclosures
required by ASC section 820-10-50, Fair Value Measurements and Disclosures: Disclosure (formerly Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157)), are included in Note 7, Investments and Fair Value
Measurements.

Restricted Cash The Company has letters of credit securing certain building leases. In
accordance with the terms of the letters of credit, the Company pledged cash for a portion of the outstanding amount. The Company had restricted cash of $0.4 million at September 30, 2009 and December 31, 2008.

Long-Lived Assets The carrying value of long-lived assets, primarily property and equipment, is evaluated whenever
events or changes in circumstances indicate that a potential impairment has occurred. A potential impairment has occurred if projected undiscounted cash flows are less than the carrying value of the assets. The estimated cash flows include
managements assumptions of cash inflows and outflows directly resulting from the use of that asset in operations. The impairment test is a two-step process. If the carrying value of the asset exceeds the expected future cash flows from the
asset, impairment is indicated. The impairment loss recognized is the excess of the carrying value of the asset over its fair value.

The Company had no impairment of long-lived assets in the nine months ended September 30, 2009 and $0.2 million in the nine months ended September 30, 2008 related to the Companys decision to invest in new switch equipment
in its Michigan and Ohio locations.

Revenue Recognition The Company generates revenue from sales of its
tandem interconnection services. The Company maintains executed service agreements with each of its customers in which specific fees and rates are determined. Revenue is recorded each month based upon documented minutes of traffic switched for which
service is provided and when collection is probable. The Company provides service primarily to large, well-established competitive carriers, including wireless, wireline and cable and broadband telephony.

Earnings Per Share Basic earnings per share is computed based on the weighted average number of shares of common stock
outstanding. Diluted earnings per share is computed based on the weighted average number of shares of common stock outstanding adjusted by the number of additional shares of common stock that would have been outstanding had the potentially dilutive
shares of common stock been issued. Potentially dilutive shares of common stock include stock options, non-vested shares and convertible warrants. The following table presents a reconciliation of the numerators and denominators of basic and diluted
earnings per share of common stock:



|                                                          |  |                                 |        |                                |   |        |  |      |        |  |   |       
|--------------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                                          |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|(In thousands, except per share amounts)                  |  | 2009                            |        | 2008                           |   | 2009   |  | 2008
|Numerator:                                                |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Net income applicable to common stockholders, as reported |  | $                               | 11,086 |                                | $ | 6,164  |  | $    | 30,804 |  | $ | 15,831
|Denominator:                                              |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Weighted average common shares outstanding                |  |                                 | 33,494 |                                |   | 32,009 |  |      | 33,017 |  |   | 31,626
|Effect of dilutive securities:                            |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Stock options                                             |  |                                 | 687    |                                |   | 1,303  |  |      | 832    |  |   | 1,492 
|Warrants                                                  |  |                                 |       |                                |   |       |  |      |       |  |   | 72    
|                                                          |  |                                 |        |                                |   |        |  |      |        |  |   |       
|                                                          |  |                                 |        |                               
|Denominator for diluted earnings per share                |  |                                 | 34,181 |                                |   | 33,312 |  |      | 33,849 |  |   | 33,190
|                                                          |  |                                 |        |                                |   |        |  |      |        |  |   |       
|                                                          |  |                                 |        |                               
|Net earnings per share:                                   |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Basic - as reported                                       |  | $                               | 0.33   |                                | $ | 0.19   |  | $    | 0.93   |  | $ | 0.50  
|                                                          |  |                                 |        |                                |   |        |  |      |        |  |   |       
|                                                          |  |                                 |        |                               
|Diluted - as reported                                     |  | $                               | 0.32   |                                | $ | 0.19   |  | $    | 0.91   |  | $ | 0.48  
|                                                          |  |                                 |        |                                |   |        |  |      |        |  |   |       



7



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NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Options to purchase 847,000, 1,489,500, 875,000 and 1,489,500 shares of common stock
were outstanding during the three months ended September 30, 2009 and September 30, 2008 and the nine months ended September 30, 2009 and September 30, 2008, respectively, but were not included in the computation of diluted
earnings per share because the effect would have been antidilutive.

295,900 non-vested shares of common stock were issued and
outstanding during the three months ended September 30, 2009, but were not included in the computation of diluted earnings per share because the effect would have been antidilutive.

Accounting for Stock-Based Compensation  The fair value of stock options is determined using the Black-Scholes valuation
model. This model takes into account the exercise price of the stock option, the fair value of the common stock underlying the stock option as measured on the date of grant and an estimation of the volatility of the common stock underlying the stock
option. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight line method. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or
updated estimates differ from the Companys current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. The Company considers many factors when estimating expected forfeitures, including
types of awards, employee class, and historical experience. Actual results, and future changes in estimates, may differ substantially from the Companys current estimates.

The amount of share-based expense recorded in the three months ended September 30, 2009 and 2008, is $1.5 million and $1.0 million,
respectively. The amount of share-based expense recorded in the nine months ended September 30, 2009 and 2008, was $3.4 million and $2.0 million, respectively.

Compensation expense for non-vested shares is measured based upon the quoted closing market price for the stock on the date of grant. The compensation cost is recognized on a straight-line basis over
the vesting period. See Note 6, Stock Options and Non-vested Shares

Recent Accounting
Pronouncements In June 2009, the FASB issued ASC No. 105, Generally Accepted Accounting Principles (ASC 105 or FASB Codification) (formerly Statement of Financial Accounting Standards (SFAS) No. 168, The FASB Accounting
Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No 162 (SFAS 168)).The effective date for use of the FASB Codification is for interim and annual periods
ending after September 15, 2009. Companies should account for the adoption of the guidance on a prospective basis. Effective July 1, 2009, the Company adopted the FASB Codification and its adoption did not have a material impact on its
condensed consolidated financial statements. The Company has appropriately updated its disclosures with the appropriate FASB Codification references during the three months ended September 30, 2009. As such, all the notes to the
condensed consolidated financial statements below as well as the critical accounting policies in the Managements Discussion and Analysis section have been updated with the appropriate FASB Codification references.

In April 2009, the FASB issued No. 820-10-35, Fair Value Measurements and Disclosures  Subsequent Measurement (ASC 820-10-35)
(formerly FSP SFAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly), which provides additional guidance on estimating fair
value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability. ASC 820-10-35 also provides additional guidance on circumstances that may indicate
that a transaction is not orderly. The above provision is effective for interim and annual periods ending after June 15, 2009. The Company adopted the provisions relating to determining the fair value when the volume and level of activity for
the asset or liability have significantly decreased and identifying transactions that are not orderly under ASC 820-10-35 during the second quarter of 2009, and its application had no impact on the Companys condensed consolidated
financial statements.



8



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##### Table of Contents

NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



In May 2009, the FASB issued ASC No. 855, Subsequent Events
(ASC 855) (formerly SFAS No. 165, Subsequent Events). ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are
available to be issued. Although the standard is based on the same principles as those that currently exist in the auditing standards, it includes a new required disclosure of the date through which an entity has evaluated subsequent events. The
Company adopted this standard effective April 1, 2009 and the Companys adoption did not have a material impact on its consolidated financial statements. The Company evaluated subsequent events through the date the accompanying financial
statements were issued, which was November 5, 2009.

3. DEBT

At
September 30, 2009, the Company has approximately $0.7 million of debt outstanding with Western Technology Investment. The amounts outstanding are summarized as follows:



|                                                                                                                                                                                               |  |                   |      |   |                  |   |        |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---- | - | ---------------- | - | ------ | -
|(Dollars in thousands)                                                                                                                                                                         |  | September 30,2009 |      |   | December 31,2008 |  
|Secured term loan, interest payable at 9.0%. Principal repaid in 36 equal installments commencing August 1, 2006. A final
payment of 9.6% of the borrowed amount was paid in July 2009         |  | $                 |     |   |                  | $ | 536    |  
|Secured term loan, interest payable at 9.25%. Principal repaid in 36 equal installments commencing October 1, 2006. A final
payment of 9.6% of the borrowed amount was paid in September 2009  |  |                   |     |   |                  |   | 686    |  
|Secured term loan, interest payable at 9.5%. Principal repaid in 36 equal installments commencing January 1, 2007. A final
payment of 9.6% of the borrowed amount is required in December 2009 |  |                   | 235  |   |                  |   | 906    |  
|Secured term loan, interest payable at 9.5%. Principal repaid in 36 equal installments commencing April 1, 2007. A final
payment of 9.6% of the borrowed amount is required in March 2010      |  |                   | 463  |   |                  |   | 1,120  |  
|Lessdiscount on debt associated with the issuance of warrants                                                                                                                                 |  |                   |     |   |                  |   | (52    | )
|                                                                                                                                                                                               |  |                   |      |   |                  |   |        |  
|                                                                                                                                                                                               |  |                  
|Total long-term debt                                                                                                                                                                           |  |                   | 698  |   |                  |   | 3,196  |  
|                                                                                                                                                                                               |  |                  
|Lesscurrent installments                                                                                                                                                                      |  |                   | (698 | ) |                  |   | (2,961 | )
|                                                                                                                                                                                               |  |                   |      |   |                  |   |        |  
|                                                                                                                                                                                               |  |                  
|Long-term debtexcluding current installments                                                                                                                                                  |  | $                 |     |   |                  | $ | 235    |  
|                                                                                                                                                                                               |  |                   |      |   |                  |   |        |  

Under the terms of its debt agreement, the Company must comply with certain negative
covenants that limit its ability to declare or pay dividends, incur additional indebtedness, incur liens, dispose of significant assets, make acquisitions or significantly change the nature of its business without the permission of the lender. For
the periods ended September 30, 2009 and December 31, 2008, the Company was in compliance with all the covenants under its debt agreement.

The Company uses cash collateralized letters of credit issued by Bank of America, NA to secure certain facility leases and other obligations. At September 30, 2009 there was $440,000 of restricted
cash used as collateral for $339,000 in letters of credit outstanding.

4. LEGAL PROCEEDINGS

From time to time, the Company is a party to legal proceedings arising in the normal course of its business. Aside from the matter discussed
below, the Company does not believe that it is a party to any pending legal action that could reasonably be expected to have a material adverse effect it our business or operating results.

Peerless Networks, LLC. On June 12, 2008, the Company commenced a patent infringement action against Peerless Networks,
LLC, Peerless Network of Illinois, LLC and John Barnicle, in the United States District Court for the Northern District of Illinois to enforce U.S. Patent No. 7,123,708 (Neutral Tandem, Inc. v Peerless Networks, LLC, Peerless Networks of
Illinois, LLC and John Barnicle, 08 CV 3402). On July 28, 2008, the defendants filed a response to the Companys complaint denying liability and asserting various affirmative defenses and counterclaims. The defendants generally allege
(i) that the Companys patent is invalid and unenforceable under a variety of theories, (ii) that assertion of the patent amounts to patent misuse and violation of certain monopolization laws, and (iii) that certain conduct
surrounding the litigation gave rise to tortious interference and business disparagement claims and Lanham Act violations. On December 4, 2008, the United States District Court for the Northern District of Illinois granted the Companys
motion to dismiss the claims alleging business disparagement and Lanham Act violations but denied the Companys motion to dismiss the claims related to the alleged violation of certain monopolization laws. On August 25, 2009, the Company
filed a motion for preliminary injunctive relief seeking to enjoin Peerless Network, LLC and Peerless Network of Illinois, LLC from providing certain tandem transit services. The preliminary injunction hearing is scheduled for November 30, 2009
and December 1, 2009. The court is not required to rule on the Companys request for injunctive relief by any specific date. Additionally, the parties continue to conduct discovery on the Companys claims and the defendants
remaining counterclaims. The Company believes that the defendants remaining allegations have no merit and intend to vigorously defend itself against these remaining counterclaims.



9



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##### Table of Contents

NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



5. INCOME TAXES

Income taxes were computed using an estimated effective tax rate, which is subject to ongoing review and evaluation by the Company. The Companys estimated effective income tax rate was 36.5% for the
three months ended September 30, 2009, compared to 35.0% for the same period last year. The Companys estimated effective income tax rate was 36.5% for the nine months ended September 30, 2009, compared to 35.9% for the same period
last year. The Companys estimated effective income tax rate varies from the statutory federal income tax rate of 35% primarily due to the impact of state income taxes, Illinois EDGE credit tax benefit and tax exempt municipal interest.

The Company files income tax returns in the U.S. federal jurisdiction, and various states and local jurisdictions. With few
exceptions, the Company is no longer subject to U.S. federal, state or local examinations for years before 2005. The Illinois Department of Revenue is scheduled to commence an examination of the Companys 2006 and 2007 Illinois income tax
returns beginning January 2010. At September 30, 2009 and December 31, 2008, the Company did not have any income tax liability due to uncertain tax positions.

6. STOCK OPTIONS AND NON-VESTED SHARES

Options

The Company established the 2003 Stock Option and Stock Incentive Plan (2003 Plan), which provided for the issuance of up to 4,650,000
options and restricted stock to eligible employees, officers, and independent contractors of the Company. In 2007 the Company adopted the Neutral Tandem, Inc. 2007 Long-Term Equity Incentive Plan (2007 Plan) and ceased awarding equity grants under
the 2003 Plan. As of September 30, 2009, the Company had granted a total of 981,723 options that remained outstanding under the 2003 Plan.

At September 30, 2009, the Company had granted a total of 2,220,500 options that remained outstanding under the 2007 Plan. Option awards for 1,170,511 shares, representing approximately 3.5% of the
Companys outstanding common stock as of September 30, 2009, remained available for additional grants under the 2007 Plan.

All options granted under the 2003 Plan and the 2007 Plan have an exercise price equal to the market value of the underlying common stock on the date of the grant. The following table shows the exercise price of one share of the
Companys common stock on each stock option grant date during the year ended December 31, 2008 and through the third quarter of fiscal 2009:



|                    |  |                               |  |                                                            |      
|------------------- |  | ----------------------------- |  | ---------------------------------------------------------- | -----
|Grant Date          |  | Number of StockOptions Issued |  | Weighted AverageExercise
Price of OneShare of Common Stock
|First Quarter 2008  |  | 9,000                         |  | $                                                          | 19.11
|Second Quarter 2008 |  | 1,360,000                     |  | $                                                          | 17.91
|Third Quarter 2008  |  | 109,000                       |  | $                                                          | 18.23
|Fourth Quarter 2008 |  | 62,000                        |  | $                                                          | 16.87
|First Quarter 2009  |  | 23,000                        |  | $                                                          | 19.50
|Second Quarter 2009 |  | 13,000                        |  | $                                                          | 28.90
|Third Quarter 2009  |  | 812,000                       |  | $                                                          | 26.06
|                    |  |                               |  |                                                            |      
|                    |  |                              
|Total               |  | 2,388,000                     |  |                                                            |      
|                    |  |                               |  |                                                            |      

The fair value of each option granted is estimated on the date of grant using the
Black-Scholes option-pricing model. The following table summarizes the assumptions used for estimating the fair value of options for the nine months ended September 30, 2009 and September 30, 2008:



|                              |  |                   |   |  |                   |  
|----------------------------- |  | ----------------- | - |  | ----------------- | -
|                              |  | September 30,2009 |   |  | September 30,2008 |  
|Expected life                 |  | 6.3 - 6.7 years   |   |  | 6.3 - 6.5 years   |  
|Risk-free interest rate range |  | 2.1% - 3.2        | % |  | 3.0% - 3.8        | %
|Expected dividends            |  |                  |   |  |                  |  
|Volatility                    |  | 54.3% - 55.6      | % |  | 41.9% - 43.8      | %

The Company utilized the simple average volatility of three telecommunication
companies that share similar business characteristics for estimating the fair value of options granted through December 31, 2008. The simple average volatility of the three companies selected ranged from 34.4% at the beginning of 2006 to 50.8%
at December 31, 2008. The Company calculated the volatility of its own stock for the period between November 2, 2007 and December 31, 2008 and found that it was not materially different than the results of the three company average.
As of January 1, 2009, the Company calculated and utilized its own volatility for estimating the fair value of options during 2009.



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NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Beginning in November 2007, the Company elected to use the simplified method to estimate
the expected term for the valuation of stock options, as permitted by Securities and Exchange Commission (SEC) under ASC 718-10, Compensation  Stock Compensation (formerly SEC Staff Accounting Bulletin 107 (SAB 107)), due to the unknown effect
on option holder behavior of the increased liquidity of the underlying options following the Companys initial public offering. The Company used the simplified method in 2008 and the first quarter of 2009. During the second quarter of 2009, the
Company determined that sufficient historical data exists regarding the actual term that employees hold their options and began to utilize its own expected term. The Companys calculated term that was used during the third quarter 2009 was
approximately 6.4 years.

The weighted-average fair value of options granted, as determined by using the Black-Scholes
valuation model, during the period was $14.45 and $8.48 for the nine months ended September 30, 2009 and 2008, respectively. The total grant date fair value of options that vested during the nine months ended September 30, 2009 and 2008
was approximately $4.3 million and $0.7 million, respectively.

The following summarizes activity under the Companys
stock option plan for the nine months ended September 30, 2009:



|                                              |  |             |   |  |                               |       |                               |   |                                     |  |    
|--------------------------------------------- |  | ----------- | - |  | ----------------------------- | ----- | ----------------------------- | - | ----------------------------------- |  | ---
|                                              |  | Shares(000) |   |  | Weighted-AverageExercisePrice |       | AggregateIntrinsicValue($000) |   | Weighted-AverageRemainingTerm (yrs)
|Options outstandingJanuary 1, 2009           |  | 3,603       |   |  | $                             | 9.03  |                               |   |                                     |  |    
|Granted                                       |  | 848         |   |  |                               | 25.92 |                               |   |                                     |  |    
|Exercised                                     |  | (1,174      | ) |  |                               | 3.62  |                               |   |                                     |  |    
|Cancelled                                     |  | (75         | ) |  |                               | 13.62 |                               |   |                                     |  |    
|                                              |  |             |   |  |                               |       |                               |   |                                     |  |    
|                                              |  |             |   | 
|Options outstandingSeptember 30, 2009        |  | 3,202       |   |  | $                             | 15.38 |                               | $ | 26,184                              |  | 8.4
|                                              |  |             |   |  |                               |       |                               |   |                                     |  |    
|                                              |  |             |   | 
|Vested or expected to vest-September 30, 2009 |  | 3,023       |   |  | $                             | 15.38 |                               | $ | 24,723                              |  | 8.4
|                                              |  |             |   |  |                               |       |                               |   |                                     |  |    
|                                              |  |             |   | 
|Exercisable-September 30, 2009                |  | 779         |   |  | $                             | 8.62  |                               | $ | 10,942                              |  | 7.3
|                                              |  |             |   |  |                               |       |                               |   |                                     |  |    

The unrecognized compensation cost associated with options outstanding at
September 30, 2009 and December 31, 2008 was $20.3 million and $12.5 million, respectively. The weighted average remaining term that the compensation will be recorded is 3.1 years and 2.8 years as of September 30, 2009 and
December 31, 2008, respectively.

Non-vested Shares

On August 26, 2009, the Companys Board of Directors granted approximately 0.3 million non-vested shares to members of the
Companys executive management team as well as various employees within the Company. The non-vested shares were issued as part of the 2007 plan. The shares vest over a four year period. The fair value of the non-vested shares is determined
using the companys closing stock price on the grant date. Compensation cost, measured using the grant date fair value, is recognized over the requisite service period on a straight line basis.

A summary of the Companys non-vested share activity and related information for the nine months ended September 30, 2009 is as
follows:



|                                 |  |             |  |                               |       |                                |   |      
|-------------------------------- |  | ----------- |  | ----------------------------- | ----- | ------------------------------ | - | -----
|                                 |  | Shares(000) |  | Weighted-AverageExercisePrice |       | AggregateIntrinsicValue ($000)
|Non-vested at January 1, 2009    |  |            |  | $                             |      |                                | $ |     
|Granted                          |  | 296         |  | $                             | 26.06 |                                | $ | 7,711
|                                 |  |             |  |                               |       |                                |   |      
|                                 |  |             | 
|Non-vested at September 30, 2009 |  | 296         |  | $                             | 26.06 |                                | $ | 7,711
|                                 |  |             |  |                               |       |                                |   |      



11



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NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



7. INVESTMENTS AND FAIR VALUE MEASUREMENTS

Investments

The following is a summary of investments as of September 30, 2009 and December 31, 2008 (in thousands):



|                       |  |                    |         |                      |   |                       |  |   |                     |   |  |   |        
|---------------------- |  | ------------------ | ------- | -------------------- | - | --------------------- |  | - | ------------------- | - |  | - | -------
|                       |  | September 30, 2009
|                       |  | AmortizedCost      |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|Money market           |  | $                  | 154,153 |                      | $ |                      |  | $ |                    |   |  | $ | 154,153
|ARStrading securities |  | $                  | 17,275  |                      | $ |                      |  | $ | (1,070              | ) |  | $ | 16,205 
|ARS rights             |  | $                  |        |                      | $ | 795                   |  | $ |                    |   |  | $ | 795    
|                       | 
|                       |  | December 31, 2008 
|                       |  | AmortizedCost      |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|Money market           |  | $                  | 106,867 |                      | $ |                      |  | $ |                    |   |  | $ | 106,867
|ARStrading securities |  | $                  | 18,825  |                      | $ |                      |  | $ | (1,957              | ) |  | $ | 16,868 
|ARS rights             |  | $                  |        |                      | $ | 1,376                 |  | $ |                    |   |  | $ | 1,376  

The following is a summary of the carrying values and balance sheet classification as
of September 30, 2009 and December 31, 2008:





|                            |  |                   |         |                  |   |        
|--------------------------- |  | ----------------- | ------- | ---------------- | - | -------
|                            |  | September 30,2009 |         | December 31,2008
|                            |  | (In thousands)   
|Cash in banks               |  | $                 | 4,078   |                  | $ | 3,547  
|Money market                |  |                   | 154,153 |                  |   | 106,867
|ARStrading securities      |  |                   | 16,205  |                  |   | 16,868 
|ARS rights                  |  |                   | 795     |                  |   | 1,376  
|Restricted cash             |  |                   | 440     |                  |   | 440    
|                            |  |                   |         |                  |   |        
|                            |  |                  
|Total                       |  | $                 | 175,671 |                  | $ | 129,098
|                            |  |                   |         |                  |   |        
|                            |  |                  
|Reported as:                |  |                   |         |                  |   |        
|Cash and cash equivalents   |  | $                 | 158,231 |                  | $ | 110,414
|Other current assets        |  |                   | 17,000  |                  |   |       
|Non-current other assets    |  |                   |        |                  |   | 18,244 
|Non-current restricted cash |  |                   | 440     |                  |   | 440    
|                            |  |                   |         |                  |   |        
|                            |  |                  
|Total                       |  | $                 | 175,671 |                  | $ | 129,098
|                            |  |                   |         |                  |   |        

As of September 30, 2009 and December 31, 2008, the Company had $154.2
million and $106.9 million, respectively, invested in money market mutual funds of which $99.3 million is guaranteed under the U.S. Department of the Treasurys Temporary Guaranty Program.

At September 30, 2009 and December 31, 2008, the Company held approximately $17.3 million (par value) and $18.8 million (par
value), respectively, of auction rate securities (ARS) investments in municipal notes. These investments were reclassified to trading securities from available for sale securities in the fourth quarter of 2008. Accordingly, they were valued at fair
value as of September 30, 2009 and December 31, 2008. The Companys ARS have an auction reset feature whose underlying assets are generally student loans which are insured in part by the federal government under the Federal Family
Education Loan Programs (FFELP). In February 2008, auctions began to fail for these securities and each auction since then has failed. The Company has since been able to liquidate $7.9 million of the securities at par value through issuer
redemptions. As of June 30, 2009, these investments were reclassified to short-term investments in accordance with the ARS Rights which allow the Company to sell its ARS back to UBS beginning June 30, 2010, which is consistent with the
Companys investment intent.

The ARS securities are valued using a discounted cash flow model that takes into
consideration the following factors among others:



| |  |  | the anticipated coupon rate for the securities;
| | - |  | -----------------------------------------------



| |  |  | a market-based discount rate;
| | - |  | -----------------------------



| |  |  | an illiquidity premium; and
| | - |  | ---------------------------



| |  |  | an anticipated workout period, or the likely timeframe to redemption or liquidation in the open market.
| | - |  | -------------------------------------------------------------------------------------------------------



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NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



In the fourth quarter 2008, the Company entered into a settlement with UBS related to
the ARS, pursuant to which the Company elected to participate in a rights offering that provides it with certain rights (ARS Rights) to sell $18.8 million (par value) of the ARS, back to UBS at par value, at any time during a two-year sale period
beginning June 30, 2010. By electing to participate in the settlement and receive the ARS Rights, the Company granted UBS the right, exercisable at any time prior to June 30, 2010 or during the two-year sale period, to purchase or cause
the sale of the Companys ARS. The ARS Rights have value in that they provide the Company with the ability to limit the length of the workout period to 18 months from the date of agreement, absent redemptions by the issuer or liquidation in the
open market. The ARS Rights were valued by analyzing the value of the underlying ARS on a stand-alone basis compared to their value along with the ARS Rights. The additional value of the ARS with the ARS Rights over the calculated value of the ARS
on a stand-alone basis represents the value of the ARS Rights.

The Companys ARS Rights are required to be recognized as
a free-standing asset, separate from the Companys ARS. The Company has elected to treat its ARS as trading securities and to measure the ARS Rights at fair value in order to match the changes in the fair value of the ARS. In the
third quarter of 2009, the Company recorded a loss of $0.1 million related to the ARS Rights and a gain of $0.2 million on the Companys ARS portfolio related to the change in fair value during the three months ended September 30, 2009.
During the first nine months of 2009, the Company recorded a loss of $0.6 million related to the ARS Rights and a gain of $0.9 million on the Companys ARS portfolio due to changes in the estimated fair value of each investment. The ARS Rights
and the ARS, which are classified as trading securities, are recorded in current other assets in the accompanying condensed consolidated balance sheet as of September 30, 2009 and recorded in non-current other assets in the accompanying
condensed consolidated balance sheet as of December 31, 2008.

The Company does not intend to hold these securities until
final maturity. The ARS and the ARS Rights will be revalued to fair market value on a quarterly basis until the sale of these securities has been completed.

Fair Value Measurement

ASC section 820-10-30, Fair Value
Measurements and Disclosures: Initial Measurement (formerly SFAS No. 157), notes that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC section
820-10-35 establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level I) observable inputs such as quoted prices in active markets; (Level II) inputs other than the quoted prices in active
markets that are observable either directly or indirectly; and (Level III) unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions. This hierarchy requires the Company to use
observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, the Company measures its investments and marketable securities at fair value.

The Companys cash equivalents are classified within Level I of the fair value hierarchy because they are valued using quoted market
prices. The types of instruments valued based on quoted market prices in active markets includes the Companys money market funds.

The types of instruments valued based on unobservable inputs in which there is little or no market data includes the Companys auction rate securities and ARS Rights. As a result of auction failures
related to the auction rate securities during the year 2008 and the nine months ended September 30, 2009, market inputs were not available as of September 30, 2009 and December 31, 2008. A discounted cash flow model has therefore been
used to determine the estimated fair value of the Companys investment in ARS as of September 30, 2009 and December 31, 2008. The assumptions used in preparing the discounted cash flow model include estimates for interest rates,
discount rates and timing and amounts of cash flows, including assumptions about the expected holding periods of these securities. Such instruments are generally classified as Level III of the fair value hierarchy.

The Companys ARS Rights were valued by determining the value of the underlying auction rate securities on a stand-alone basis compared
to their value along with the ARS Rights. The Company utilized the same factors that were used to value its investment in ARS.

The Company does not have liabilities measured at fair value on a recurring basis. The following table summarizes the Companys assets that are measured at fair value on a recurring basis:



|                                    |  |                    |         |          |   |           |  |       |        |  |   |        
|----------------------------------- |  | ------------------ | ------- | -------- | - | --------- |  | ----- | ------ |  | - | -------
|                                    |  | September 30, 2009
|                                    |  | Level I            |         | Level II |   | Level III |  | Total
|                                    |  | (In thousands)    
|Investments:                        |  |                    |         |          |   |           |  |       |        |  |   |        
|Money market funds                  |  | $                  | 154,153 |          | $ |          |  | $     |       |  | $ | 154,153
|ARStrading securities              |  |                    |        |          |   |          |  |       | 16,205 |  |   | 16,205 
|                                    |  |                    |         |          |   |           |  |       |        |  |   |        
|                                    |  |                    |         |         
|Total investments                   |  | $                  | 154,153 |          | $ |          |  | $     | 16,205 |  | $ | 170,358
|                                    |  |                    |         |          |   |           |  |       |        |  |   |        
|                                    |  |                    |         |         
|ARS rights                          |  |                    |        |          |   |          |  |       | 795    |  |   | 795    
|                                    |  |                    |         |          |   |           |  |       |        |  |   |        
|                                    |  |                    |         |         
|Total assets measured at fair value |  | $                  | 154,153 |          | $ |          |  | $     | 17,000 |  | $ | 171,153
|                                    |  |                    |         |          |   |           |  |       |        |  |   |        



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NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Unrealized gains and losses associated with Level III financial instruments were
recorded in the Companys condensed consolidated statement of income as other (income) expense. The unrealized gain associated with ARS-trading securities for the three months ended September, 2009 was approximately $0.2 million and was
approximately $0.9 million for the nine month period ended September 30, 2009. The unrealized loss associated with the ARS Rights for the three months ended September 30, 2009 was approximately $0.1 million and was approximately $0.6
million for the nine month period ended September 30, 2009.

The following table summarizes the change in balance sheet
carrying value associated with Level III financial instruments carried at fair value during the period ended September, 2009 (in thousands):



|                       |  |                  |        |                               |          |        |                       |  |                |   |  |                   |   |  |   |      |   |  |   |       
|---------------------- |  | ---------------- | ------ | ----------------------------- | -------- | ------ | --------------------- |  | -------------- | - |  | ----------------- | - |  | - | ---- | - |  | - | ------
|                       |  | December 31,2008 |        | Payment,Purchases(Sales), Net |          |        | TransfersIn (Out),Net |  | Gains (Losses) |   |  | September 30,2009
|                       |  |                  |        |                               | Realized |        | Unrealized            |  |               
|ARStrading securities |  | $                | 16,868 |                               | $        | (1,550 | )                     |  | $              |  |  | $                 |  |  | $ | 887  |   |  | $ | 16,205
|ARS rights             |  |                  | 1,376  |                               |          |       |                       |  |                |  |  |                   |  |  |   | (581 | ) |  |   | 795   
|                       |  |                  |        |                               |          |        |                       |  |                |   |  |                   |   |  |   |      |   |  |   |       
|                       |  |                  |        |                               |          |       
|Total                  |  | $                | 18,244 |                               | $        | (1,550 | )                     |  | $              |  |  | $                 |  |  | $ | 306  |   |  | $ | 17,000
|                       |  |                  |        |                               |          |        |                       |  |                |   |  |                   |   |  |   |      |   |  |   |       

8. COMPREHENSIVE INCOME (LOSS)

Comprehensive income consists of net income and other comprehensive loss. Other comprehensive loss includes certain changes in equity that
are excluded from net income. Specifically, unrealized holding losses on available-for-sale investments are included in accumulated other comprehensive loss in the consolidated balance sheets.

The components of other accumulated comprehensive loss are as follows (in thousands):



|                                                                                   |  |                    |   |                   |   |                   |  |                   |   |  |   |      |  
|---------------------------------------------------------------------------------- |  | ------------------ | - | ----------------- | - | ----------------- |  | ----------------- | - |  | - | ---- | -
|                                                                                   |  | Three Months Ended |   | Nine Months Ended |  
|                                                                                   |  | September 30,2009  |   | September 30,2008 |   | September 30,2009 |  | September 30,2008 |  
|Net unrealized holding income (loss) on available-for-sale investments, net of tax |  | $                  |  |                   | $ | 553               |  | $                 |  |  | $ | (140 | )
|                                                                                   |  |                    |   |                   |   |                   |  |                   |   |  |   |      |  
|                                                                                   |  |                    |   |                  
|Total other accumulated comprehensive income (loss)                                |  | $                  |  |                   | $ | 553               |  | $                 |  |  | $ | (140 | )
|                                                                                   |  |                    |   |                   |   |                   |  |                   |   |  |   |      |  

The following table reconciles net income to comprehensive income for the periods
ended September 30, 2009 and September 30, 2008 (in thousands):



|                                  |  |                    |        |                   |   |                   |  |                   |        |  |   |        |  
|--------------------------------- |  | ------------------ | ------ | ----------------- | - | ----------------- |  | ----------------- | ------ |  | - | ------ | -
|                                  |  | Three Months Ended |        | Nine Months Ended |  
|                                  |  | September 30,2009  |        | September 30,2008 |   | September 30,2009 |  | September 30,2008 |       
|Net income                        |  | $                  | 11,086 |                   | $ | 6,164             |  | $                 | 30,804 |  | $ | 15,831 |  
|Other comprehensive income (loss) |  |                    |       |                   |   | 553               |  |                   |       |  |   | (140   | )
|                                  |  |                    |        |                   |   |                   |  |                   |        |  |   |        |  
|                                  |  |                    |        |                  
|Total comprehensive income        |  | $                  | 11,086 |                   | $ | 6,717             |  | $                 | 30,804 |  | $ | 15,691 |  
|                                  |  |                    |        |                   |   |                   |  |                   |        |  |   |        |  



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NEUTRAL TANDEM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



9. SEGMENT AND GEOGRAPHIC INFORMATION

ASC 280, Segment Reporting (formerly SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information),
establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating
decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.

The
Companys chief operating decision maker is the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis. The Company operates in one industry segment, which is to provide tandem
interconnection services to competitive carriers, including wireless, wireline, cable and broadband telephony providers. Therefore, the Company has concluded that it has only one operating segment. Although the Company services different customer
groups, it does not maintain separate product lines. All of the Companys revenues are generated within the United States.



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

This quarterly report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, as well as
assumptions that, if they never materialize or prove incorrect, could cause our actual results to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include any expectations relating
to earnings, revenues or other financial items; any statements of the plans, strategies and objectives of management for future operations; factors that may affect our operating results; statements concerning new products or services; statements
related to future capital expenditures; statements related to future economic conditions or performance; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any
of the foregoing. These statements are often identified by the use of words such as anticipate, believe, continue, could, estimate, expect, intend, may,
or will, and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to them. Such forward-looking statements are subject to risks,
uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that might cause such differences include, but
are not limited to: the impact of current and future regulation affecting the telecommunications industry; technological developments; the effects of competition; natural or man-made disasters; the impact of current or future litigation; the ability
to attract, develop and retain executives and other qualified employees; the ability to obtain and protect intellectual property rights; changes in general economic or market conditions; and other important factors included in our reports filed with
the Securities and Exchange Commission, particularly in the Risk Factors section of our Annual Report on Form 10-K for the period ended December 31, 2008 and included elsewhere in this report. Furthermore, such forward-looking
statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

We provide tandem interconnection services principally to competitive carriers, including wireless, wireline, cable and broadband telephony companies. Competitive carriers use tandem switches to interconnect and exchange local and long
distance traffic between their networks without the need to establish direct switch-to-switch connections. Prior to the introduction of our service, the primary method for competitive carriers to exchange traffic indirectly was through the use of
the incumbent local exchange carriers, or ILECs, tandem switches. The tandem switching services offered by ILECs consist of transit services, which are provided in connection with local calls, and access services, which are provided in
connection with long distance calls. Under certain interpretations of the Telecommunications Act of 1996 and implementing regulations, ILECs are required to provide tandem transit services to competitive carriers. ILECs generally set per minute
rates and other charges for tandem transit services according to rate schedules approved by state public utility commissions, although the methodology used to review these rate schedules varies from state to state. ILECs are also required to offer
access services to competing telecommunications carriers under the Telecommunications Act of 1996 and implementing regulations. ILECs generally set per minute rates and other charges for access services according to mandated rate schedules set by
the Federal Communications Commission, or FCC, for interstate calls and by state public utility commissions for intrastate calls. Our services enable competitive carriers to exchange traffic between their networks without using an ILEC tandem for
both local and long distance calls.

The proliferation of competitive carriers after the passage of the Telecommunications Act
of 1996 and their capture of an increasing share of subscribers shifted a greater amount of intercarrier traffic to ILEC tandem switches and amplified the complexity of carrier interconnections. This resulted in additional traffic loading of ILEC
tandems, lower service quality and substantial costs incurred by competitive carriers for interconnection. A loss of ILEC market share to competitive carriers escalated competitive tensions and resulted in an increased demand for tandem switching.

We founded our company to solve these interconnection problems and better facilitate the exchange of traffic among
competitive carriers and non-carriers. By utilizing our managed tandem solution, our customers benefit from a simplified interconnection network solution which reduces costs, increases network reliability, decreases competitive tension and adds
network diversity and redundancy. We have signed agreements with major competitive carriers and non-carriers and we operated in 128 markets as of September 30, 2009.



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For the three months ended September 30, 2009, we increased revenue to $44.7 million,
an increase of 43.5% compared to the three months ended September 30, 2008. The increase in revenue was primarily due to an increase of minutes of use to 23.0 billion minutes processed in the three months ended September 30, 2009 from 15.9
billion minutes processed in the three months ended September 30, 2008, an increase of 44.7%. Our income from operations for the three months ended September 30, 2009 was $17.3 million compared to $8.8 million for the three month ended
September 30, 2008. Net income for the three months ended September 30, 2009, was approximately $11.1 million compared to net income of $6.2 million for the three months ended September 30, 2008.

For the nine months ended September 30, 2009, we increased revenue to $124.2 million, an increase of 44.5% compared to the nine months
ended September 30, 2008. The increase in revenue was primarily due to an increase of minutes of use to 64.0 billion minutes processed in the nine months ended September 30, 2009 from 42.9 billion minutes processed in the nine months ended
September 30, 2008, an increase of 49.0%. Our income from operations for the nine months ended September 30, 2009 was $47.8 million compared to $23.4 million for the nine months ended September 30, 2008. Net income for the nine months
ended September 30, 2009, was approximately $30.8 million compared to net income of $15.8 million for the nine months ended September 30, 2008.

Revenue

We generate revenue from the sale of our managed tandem
interconnection services. Revenue is recorded each month based upon minutes of traffic switched by our network by each customer, which we refer to as minutes of use. The rates charged per minute are determined by contract between us and our
customers. The following table sets forth our revenue, minutes of use and the average rate we charged per minute for the three months and nine months ended September 30, 2009 and 2008.



|                                    |  |                                 |        |                                |   |        |  |      |         |  |   |       
|----------------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------- |  | - | ------
|                                    |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                                    |  | 2009                            |        | 2008                           |   | 2009   |  | 2008
|Revenue (in thousands)              |  | $                               | 44,692 |                                | $ | 31,154 |  | $    | 124,176 |  | $ | 85,958
|Minutes of Use Billed (in millions) |  |                                 | 22,953 |                                |   | 15,855 |  |      | 63,961  |  |   | 42,936
|Average fee per billed minute       |  | $                               | 0.0019 |                                | $ | 0.0020 |  | $    | 0.0019  |  | $ | 0.0020

Minutes of use increase as we increase our number of customers, enter new markets,
increase the penetration of existing markets, either with new customers or with existing customers and increase our service offerings. The minutes of use decrease due to direct connection between existing customers, consolidation between customers,
a customer using a different interconnection provider or a customer experiences a decrease in the volume of traffic it carries.

The average fee per minute varies depending on market forces and type of service, such as switched access or local transit. The market rate in each market is based upon competitive conditions along with the switched access or local transit
rates offered by the ILECs. Depending on the markets we enter, we may enter into contracts with our customers with either a higher or lower fee per minute than our current average. For example, although we regard the 28 additional markets we added
during the first nine months of 2009 and the 36 additional markets added in 2008 as financially attractive, the rates we charge in those markets for local transit services are generally lower than the rates we charge in the markets we initially
opened in 2004. We expect the average fee per billed minute to continue to decrease as we add new markets with lower fees per minute than our current average and as a result of the competitive environment in our marketplace.

Although we expect that the total number of minutes switched by our network will increase as we enter new markets, our revenues would
decrease if our average fee per minute were to continue to decline and we were unable to increase the total number of minutes switched by our network.

Our service solution incorporates other components beyond switching. In addition to switching, we provision trunk circuits between our customers switches and our network locations at our own expense
and at no direct cost to our customers. We also provide quality of service monitoring, call records and traffic reporting and other services to our customers as part of our service solution. Our per-minute fees are intended to incorporate all of
these services.

While generally not seasonal in nature, our revenues are affected by certain events such as holidays, the
unpredictable timing of direct connects between our customers, the loss of a customer and installation and implementation delays. These factors can cause our revenue to both increase or decrease unexpectedly.

Operating Expense

Operating expenses include network and facilities expense, operations expenses, sales and marketing expenses, general and administrative expenses, depreciation and amortization and the gain on the disposal of fixed assets. Personnel-related
costs are the most significant component as we grew to 142 employees at September 30, 2009 from 134 employees at September 30, 2008.



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Network and Facilities Expense. Our network and facilities expense includes transport
and signaling network costs, facility rents and utilities, together with other costs that directly support the switch locations. We do not defer any costs associated with the start-up of new switch locations and we do not capitalize any costs. The
start-up of an additional switch location can take between three months to six months. During this time we typically incur facility rent, utilities, payroll and related benefit costs along with initial non-recurring circuit installation costs.
Revenues generally follow sometime after the sixth month.

Network transport costs typically occur on a repeating monthly
basis, which we refer to as recurring costs, or on a one-time basis, which we refer to as non-recurring costs. Recurring transport costs primarily include monthly usage charges from telecommunication carriers and are related to the circuits utilized
by us to interconnect our customers. As our traffic increases, we must utilize additional circuits. Non-recurring transport costs primarily include the initial installation of such circuits. Facility rents include the leases on our switch
facilities, which expire through August 2019. Additionally, we pay the cost of all the utilities for all of our switch locations.

The largest component of our other costs relates to charges we pay to utilize the ILEC services. We incur some monthly charges from the ILECs as we diversify our network and provide alternative routes to complete our customers
traffic. In some cases, we may not have sufficient capacity of network transport lines installed in our own network to handle the volume of traffic destined for a particular customer. In this case, we will incur these charges, generally temporarily,
in order to maintain a high quality of service. We attempt to minimize these charges by managing our network, recognizing when additional capacity is required and working with our customers to augment the transport capacity required between our
network and theirs.

Operations Expenses. Operations expenses include payroll and benefits for both our switch location
personnel as well as individuals located at our corporate office who are directly responsible for maintaining and expanding our switch network. Other primary components of operations expenses include switch repair and maintenance, property taxes,
property insurance and supplies.

Sales and Marketing Expense. Sales and marketing expenses primarily include
personnel costs, sales bonuses, marketing programs and other costs related to travel and customer meetings.

General and
Administrative Expense. General and administrative expenses consist primarily of compensation and related costs for personnel and facilities associated with our executive, finance, human resource and legal departments and fees for professional
services. Professional services principally consist of outside legal, audit and other accounting costs. The other accounting costs relate to work surrounding compliance with the Sarbanes-Oxley Act.

Depreciation and Amortization Expense. Depreciation and amortization expense is applied using the straight-line method over the
estimated useful lives of the assets after they are placed in service, which are five years for switch equipment and test equipment, three years for computer equipment, computer software and furniture and fixtures. Leasehold improvements are
amortized on a straight-line basis over an estimated useful life of five years or the life of the respective leases, whichever is shorter.

Gain on disposal of fixed assets. We have disposed of switch equipment in connection with converting to new technology and computer equipment to replace old or damaged units. When there is a
carrying value of these assets, we record the write-off of these amounts to loss on disposal. In some cases, this equipment is sold to a third party. When the proceeds from the sale of equipment identified for disposal exceeds the assets
carrying value, we record a gain on disposal.

Interest Income (Expense). Interest expense consists of interest
paid each month related to our outstanding equipment loans associated with our security agreement with an affiliate of Western Technology Investment. We record accrued interest each month associated with a final payment for each loan equal to
9.6% of the original principal loan amount. Interest expense also includes an amount related to the amortization of the value of debt discount associated with warrants issued to an affiliate of Western Technology Investment. Interest income is
earned primarily on our cash, cash equivalents and our investment in ARS.

Other (Income) Expense. Other (income)
expense includes adjustments to the fair value of the ARS, adjustments to the fair value of the ARS Rights and expenses incurred in connection with the secondary offering by certain of our shareholders completed in the first quarter of 2008.

Income Taxes. Income tax provision includes U.S. federal, state, and local income taxes and is based on pre-tax
income. The interim period provision for income taxes is based upon our estimated annual effective income tax rate. In determining the estimated annual effective income tax rate, we analyze various factors, including projections of our annual
earnings and taxing jurisdictions in which earnings will be generated, the impact of state and local income taxes and our ability to use tax credits and net operating loss carryforwards.

Critical Accounting Policies and Estimates

The preparation of our financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the periods
presented. Our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, which we filed with the Securities and Exchange Commission on March 13, 2009, includes a summary of the critical



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accounting policies we believe are the most important to aid in understanding our financial results. There have been no changes to those critical accounting policies that have had a material
impact on our reported amounts of assets, liabilities, revenues or expenses during the first nine months of 2009.

Results of Operations

The following table sets forth our results of operations for the three months and
nine months ended September 30, 2009 and 2008:



|                                                                                |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                                                |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|(Dollars in thousands)                                                          |  | 2009                            |        |   | 2008                           |   |        | 2009 |  |   | 2008    |  
|Revenue                                                                         |  | $                               | 44,692 |   |                                | $ | 31,154 |      |  | $ | 124,176 |   |  | $ | 85,958 |  
|Operating expense:                                                              |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Network and facilities expense (excluding depreciation and amortization)        |  |                                 | 13,093 |   |                                |   | 11,215 |      |  |   | 36,987  |   |  |   | 29,711 |  
|Operations                                                                      |  |                                 | 4,991  |   |                                |   | 4,288  |      |  |   | 14,795  |   |  |   | 12,485 |  
|Sales and marketing                                                             |  |                                 | 467    |   |                                |   | 466    |      |  |   | 1,465   |   |  |   | 1,461  |  
|General and administrative                                                      |  |                                 | 5,375  |   |                                |   | 2,801  |      |  |   | 12,468  |   |  |   | 9,013  |  
|Depreciation and amortization                                                   |  |                                 | 3,506  |   |                                |   | 3,561  |      |  |   | 10,746  |   |  |   | 9,647  |  
|Impairment of fixed assets                                                      |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   | 195    |  
|Gain on disposal of fixed assets                                                |  |                                 | (28    | ) |                                |   |       |      |  |   | (53     | ) |  |   |       |  
|                                                                                |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Total operating expense                                                         |  |                                 | 27,404 |   |                                |   | 22,311 |      |  |   | 76,408  |   |  |   | 62,512 |  
|                                                                                |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Income from operations                                                          |  |                                 | 17,288 |   |                                |   | 8,823  |      |  |   | 47,768  |   |  |   | 23,446 |  
|                                                                                |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Other (income) expense:                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Interest expense, including debt discount of $8, $22, $52 and $73, respectively |  |                                 | 49     |   |                                |   | 208    |      |  |   | 276     |   |  |   | 757    |  
|Interest income                                                                 |  |                                 | (159   | ) |                                |   | (870   | )    |  |   | (707    | ) |  |   | (2,567 | )
|Other (income) expense                                                          |  |                                 | (65    | ) |                                |   |       |      |  |   | (306    | ) |  |   | 550    |  
|                                                                                |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Total other (income) expense                                                    |  |                                 | (175   | ) |                                |   | (662   | )    |  |   | (737    | ) |  |   | (1,260 | )
|                                                                                |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Income before income taxes                                                      |  |                                 | 17,463 |   |                                |   | 9,485  |      |  |   | 48,505  |   |  |   | 24,706 |  
|Provision for income taxes                                                      |  |                                 | 6,377  |   |                                |   | 3,321  |      |  |   | 17,701  |   |  |   | 8,875  |  
|                                                                                |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Net income                                                                      |  | $                               | 11,086 |   |                                | $ | 6,164  |      |  | $ | 30,804  |   |  | $ | 15,831 |  
|                                                                                |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  

Three Months Ended September 30, 2009 Compared to Three Months Ended
September 30, 2008

Revenue. Revenue increased to $44.7 million in the three months ended September 30,
2009 from $31.2 million in the three months ended September 30, 2008, an increase of 43.5%. The increase in revenue was primarily due to an increase of minutes of use to 23.0 billion minutes processed in the three months ended
September 30, 2009 from 15.9 billion minutes processed in the three months ended September 30, 2008, an increase of 44.7%. The increase in the number of minutes processed by the Companys network was a result of further penetration of
current markets and customers, as well as the entry into 37 new markets since September 30, 2008.

Operating
Expenses. Operating expenses for the three months ended September 30, 2009 of $27.4 million increased $5.1 million, or 22.8%, from $22.3 million for the three months ended September 30, 2008. The components making up operating
expenses are discussed further below.

Network and Facilities Expenses. Network and facilities expenses increased to
$13.1 million in the three months ended September 30, 2009, or 29.3% of revenue, from $11.2 million in the three months ended September 30, 2008, or 36.0% of revenue. Network and facilities expenses increased due to an increase in the
number of switch locations we connect, increasing by 900 switch locations to 2,138 switch locations at September 30, 2009 from 1,238 switch locations at September 30, 2008. In addition, our switch related costs, primarily made up of
facility rent and utilities costs, increased as our number of locations at the end of September 30, 2009 grew to 33 compared to 30 locations at September 30, 2008.

Operations Expenses. Operations expenses increased to $5.0 million in the three months ended September 30, 2009, or 11.2% of
revenue, from $4.3 million in the three months ended September 30, 2008, or 13.8% of revenue. The increase in our operations expenses resulted from an increase in payroll and benefits, due to an increase in the number of switch location
personnel, as well as individuals located at our corporate office who are directly responsible for maintaining and expanding our switch network.



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Sales and Marketing Expense. Sales and marketing expense remained the same at
$0.5 million in the three months ended September 30, 2009, or 1.0% of revenue, compared to $0.5 million in the three months ended September 30, 2008, or 1.5% of revenue. We have successfully increased revenues while maintaining the same
approximate size of the sales and marketing force at September 30, 2009.

General and Administrative Expense.
General and administrative expense increased to $5.4 million in the three months ended September 30, 2009, or 12.0% of revenue, compared with $2.8 million in the three months ended September 30, 2008, or 9.0% of revenue. The increase in
our general and administrative expense is primarily due to an increase of $0.2 million in salaries, $0.5 million in non-cash compensation and $1.9 million in professional fees.

Depreciation and Amortization Expense. Depreciation and amortization expense decreased to $3.5 million in the three months ended
September 30, 2009, or 7.8% of revenue, compared to $3.6 million in the three months ended September 30, 2008, or 11.4% of revenue.

Gain on Disposal of Fixed Assets. In the three months ended September 30, 2009, we sold equipment in which we received less than $0.1 million. The equipment did not have any carrying value at
the time of sale. During the three months ended September 30, 2008, we did not have any gain or loss on disposal of equipment.

Other (Income) Expense. Other income of $0.2 million for the three months ended September 30, 2009 decreased $0.5 million compared to other income of $0.7 million for the three months ended September 30, 2008. Interest
expense decreased due to lower average outstanding borrowing amounts while investment income decreased due to lower average investment rates.

Provision for Income Taxes. Provision for income taxes of $6.4 million for the three months ended September 30, 2009 increased by $3.1 million compared to $3.3 million for the three
months ended September 30, 2008. The effective tax rate for the three months ended September 30, 2009 and 2008 was 36.5% and 35.0%, respectively.

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

Revenue. Revenue was $124.2 million for the nine months ended September 30, 2009, an increase of $38.2 million, or 44.5%, from $86.0 million for the nine months ended September 30, 2008.
The increase in revenue was primarily due to an increase of minutes of use to 64.0 billion minutes processed in the nine months ended September 30, 2009 from 42.9 billion minutes processed in the nine months ended September 30, 2008, an
increase of 49.0%.

Operating Expenses. Operating expenses were $76.4 million for the nine months ended
September 30, 2009, an increase of $13.9 million from $62.5 million for the nine months ended September 30, 2008, or 61.5% and 72.7% of revenue, respectively. The components making up operating expenses are discussed further below.

Network and Facilities Expenses. Network and facilities expenses were $37.0 million for the nine months ended
September 30, 2009, or 29.8% of revenue, an increase from $29.7 million for the nine months ended September 30, 2008, or 34.6% of revenue. Network and facilities expenses increased due to an increase in the number of switch locations we
connect, increasing by 900 switch locations to 2,138 switch locations at September 30, 2009 from 1,238 switch locations at September 30, 2008. In addition, our switch related costs, primarily made up of facility rent and utilities costs,
increased as our number of switch locations at the end of September 30, 2009 grew to 33 compared to 30 switch locations at September 30, 2008.

Operations Expenses. Operations expenses were $14.8 million for the nine months ended September 30, 2009, or 11.9% of revenue, an increase of $2.3 million compared to $12.5 million for the
nine months ended September 30, 2008, or 14.5% of revenue. The increase in our operations expenses is primarily due to an increase of $1.3 million in payroll and benefits, due to an increase in the number of switch location personnel, along
with an increase of $1.0 million due to higher switch repair, maintenance and insurance expenses.

Sales and Marketing
Expense. Sales and marketing expense was $1.5 million for the nine months ended September 30, 2009, or 1.2% of revenue, is unchanged from $1.5 million for the nine months ended September 30, 2008, or 1.7% of revenue. We have
successfully increased revenues while maintaining the same approximate size of the sales and marketing force.

General and
Administrative Expense. General and administrative expense increased to $12.5 million in the nine months ended September 30, 2009, or 10.0% of revenue, from $9.0 million for the nine months ended September 30, 2008, or 10.5% of
revenue. The increase in our general and administrative expense is primarily due to an increase of $0.4 million in salaries, $1.4 million in non-cash compensation and an increase of $1.5 million in professional fees.

Depreciation and Amortization Expense. Depreciation and amortization expense increased to $10.7 million in the nine months ended
September 30, 2009, or 8.7% of revenue, compared to $9.6 million in the nine months ended September 30, 2008, or 11.2% of



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revenue. The increase in our depreciation and amortization expense resulted from capital expenditures related to the expansion of switch capacity in existing markets and the installation of
switch capacity in new markets. Accelerated depreciation of $0.8 million and $1.0 million was recorded in the nine months ended September 30, 2009 and 2008, respectively, which was related to our conversion to new switch equipment in our
Illinois, Indiana and Minnesota locations in 2009 and our New York, Michigan and Ohio locations in 2008.

Impairment of
Fixed Assets.Impairment of fixed assets was approximately $0.2 million for the nine months ended September 30, 2008 compared to no impairment of fixed assets for the nine months ended September 30, 2009. See footnote 2 to the
condensed consolidated financial statements  Long-lived Assets.

Gain on disposal of fixed assets. In
the nine months ended September 30, 2009, we sold equipment in which we received less than $0.1 million. The equipment did not have any carrying value at the time of sale. During the nine months ended September 30, 2008, we did not have
any gain or loss on disposal of equipment.

Other (Income) Expense. Other income was $0.7 million in the nine
months ended September 30, 2009 compared to $1.3 million for the nine months ended September 30, 2008. The decrease is the result of lower average interest rates earned on investments during 2009.

Provision for Income Taxes. Provision for income taxes was $17.7 million for the nine months ended September 30, 2009, an
increase of $8.8 million compared to $8.9 million for the nine months ended September 30, 2008. The effective tax rate for the nine months ended September 30, 2009 and 2008 was 36.5% and 35.9%, respectively.

Liquidity and Capital Resources



|                                         |  |                   |         |   |                   |   |         |  
|---------------------------------------- |  | ----------------- | ------- | - | ----------------- | - | ------- | -
|                                         |  | September 30,2009 |         |   | December 31,2008  |  
|Working capital                          |  | $                 | 185,796 |   |                   | $ | 120,431 |  
|Cash and cash equivalents                |  |                   | 158,231 |   |                   |   | 110,414 |  
|Investment in ARS                        |  |                   | 17,000  |   |                   |   | 18,244  |  
|Restricted cash                          |  |                   | 440     |   |                   |   | 440     |  
|                                         | 
|                                         |  | Nine Months Ended |        
|                                         |  | September 30,2009 |         |   | September 30,2008 |  
|Net cash flows from operating activities |  | $                 | 45,354  |   |                   | $ | 24,302  |  
|Net cash flows from investing activities |  |                   | (8,254  | ) |                   |   | (34,080 | )
|Net cash flows from financing activities |  |                   | 10,717  |   |                   |   | 4,038   |  

At December 31, 2008, cash and cash equivalents consisted of highly liquid money
market funds and long-term investments consisted of auction rate securities and ARS Rights. The restricted cash balance amounts are pledged as collateral for certain commercial letters of credit. At September 30, 2009, cash and cash equivalents
consisted of highly liquid money market funds and short-term investments consisted of auction rate securities and ARS Rights.

Cash flows from operating activities

Net cash provided by operating activities was $45.4 million for the nine
months ended September 30, 2009, compared to $24.3 million for the same period last year. Operating cash inflows are largely attributable to payments from customers which are generally received between 35 to 45 days following the end of the
billing month. Operating cash outflows are largely attributable to personnel related expenditures, facility and switch maintenance costs. The increase in operating cash flow reflects high operating earnings driven by a significant increase in
minutes billed, partially offset by increases in accounts receivable and non-cash tax benefits associated with stock option exercises.

Recent economic conditions have made the availability of credit for working capital purposes more difficult to obtain. If these conditions continue, it may impact our customers ability to pay their obligations to us as they become due
and consequently impact our cash flows from operating activities. While we do not believe we have been materially impacted by these conditions to date, the magnitude of such impact, if any, is not known.



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We believe that cash flow from operating activities, in addition to cash and cash
equivalents currently on-hand, will be sufficient to fund our operations, including our anticipated growth plans, for the foreseeable future and in any event for at least the next 12 to 18 months. Given the generally negative and highly volatile
global economic climate and the challenges and uncertainties in the global credit markets, however, no assurance can be given that this will be the case.

We regularly review acquisitions and additional strategic opportunities, which may require additional debt or equity financing. We currently do not have any pending agreements with respect to any
acquisitions or strategic opportunities.

Cash flows from investing activities

Net cash used for investing activities was $8.3 million for the first nine months of 2009, compared to $34.1 million for the same period last
year. Investing cash outflows are primarily related to purchases of switch equipment and the purchase of investments. The decrease in investing cash flow is the result of a decrease in the purchase of equipment and investments during the current
period, partially offset by a decrease in proceeds from the sale of investments.

In the next twelve months, capital
expenditures are expected to be in the range of approximately $20.0 million, primarily for the expansion into new locations and the expansion and upgrades of current locations.

Cash flows from financing activities

Net cash provided by financing activities was $10.7 million for the first nine months of 2009, compared to $4.0 million for the same period last year. The changes in cash flows from financing activities
primarily relate to the exercise of stock options and payments under our debt obligations. The increase in financing activities is the result of an increase in the proceeds from the issuance of common stock associated with stock options, an increase
in the excess tax benefit associated with stock option expense and a decrease in principal repayments of long-term debt.

Investments

We held approximately $17.3 million (par value) and $18.8 million (par value) of municipal note
investments at September 30, 2009 and December 31, 2008, respectively. These investments were valued at fair value as of September 30, 2009. As such, in the third quarter of 2009 we recorded a gain of $0.2 million and $0.9 million for
the three and nine months ended September 30, 2009, respectively, related to investments in auction rate securities. Our auction rate securities had an auction reset feature whose underlying assets are generally student loans which are insured
in part by the federal government under the Federal Family Education Loan Programs (FFELP). Our ARS Rights are required to be recognized as a free-standing asset, separate from the Companys ARS. As such, the Company recorded a loss of
approximately $0.1 million and $0.6 million for the three and nine months ended September 30, 2009, respectively, related to the ARS Rights.

We also invest our excess cash in money market mutual funds which are carried at market value. As of September 30, 2009, we had $154.2 million in cash and cash equivalents invested in two money
market mutual funds.

For further discussion of these investments see footnote 7 to the condensed consolidated financial
statements  Investments and Fair Value Measurements included elsewhere herein.

Debt and Credit
Facilities

We have an equipment loan and security agreement with an affiliate of Western Technology Investment, which
initially provided us with up to $19.5 million in available credit. As of September 30, 2009, we had approximately $0.7 million of debt outstanding under this agreement. For further discussion of this equipment loan and security agreement see
footnote 3 to the condensed consolidated financial statements  Debt.

Effect of Inflation

Inflation generally affects us by increasing our cost of labor and equipment. We do not believe that inflation had any
material effect on our results of operations for the nine month periods ended September 30, 2009 and 2008.



|Item 3. | Qualitative and Quantitative Disclosure about Market Risk
|------- | ---------------------------------------------------------

Interest rate exposure

We had cash, cash equivalents, short-term
investments and restricted cash totaling $175.7 million at September 30, 2009. This amount was allocated primarily in money market funds, ARS and associated ARS Rights. The unrestricted cash and cash equivalents are held for working capital
purposes. We do not enter into investments for speculative purposes. At September 30, 2009, we had $154.2 million in cash and cash equivalents invested in two money market mutual funds and $17.0, in the aggregate, in ARS and ARS Rights. For
further discussion of these investments see footnote 7 to the condensed consolidated financial statementsInvestments and Fair Value Measurements.



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None of our indebtedness discussed in footnote 3 to the condensed consolidated financial
statementsDebt above bears interest at a variable rate.

Based upon our overall interest rate exposure at
September 30, 2009, we do not believe that a hypothetical 10 percent change in interest rates over a one year period would have a material impact on our earnings, fair values or cash flows from interest rate risk sensitive instruments discussed
above.



|Item 4. | Controls and Procedures
|------- | -----------------------

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Companys reports under the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to the Companys management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Evaluation

The Company carried out an evaluation, under the supervision, and with the participation, of the Companys management, including the Companys Chief Executive Officer and the Companys Chief Financial Officer, of the
effectiveness of the Companys disclosure controls and procedures as of September 30, 2009. Based on the foregoing, the Companys Chief Executive Officer and principal financial officers concluded that the Companys disclosure
controls and procedures were effective as of September 30, 2009 at the reasonable assurance level.

There have been no
changes during the nine months ended September 30, 2009 covered by this report in the Companys internal control over financial reporting or in other factors that could materially affect or are reasonably likely to materially affect the
internal control over financial reporting

PART II. OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

From
time to time, we are a party to legal proceedings arising in the normal course of our business. Aside from the matter discussed below, we do not believe that we are party to any pending legal action that could reasonably be expected to have a
material adverse effect on our business or operating results.

Peerless Networks, LLC. On June 12, 2008, we
commenced a patent infringement action against Peerless Networks, LLC, Peerless Network of Illinois, LLC and John Barnicle, in the United States District Court for the Northern District of Illinois to enforce U.S. Patent No. 7,123,708
(Neutral Tandem, Inc. v Peerless Networks, LLC, Peerless Networks of Illinois, LLC and John Barnicle, 08 CV 3402). On July 28, 2008, the defendants filed a response to our complaint denying liability and asserting various affirmative
defenses and counterclaims. The defendants generally allege (i) that our patent is invalid and unenforceable under a variety of theories, (ii) that assertion of the patent amounts to patent misuse and violation of certain monopolization
laws, and (iii) that certain conduct surrounding the litigation gave rise to tortious interference and business disparagement claims and Lanham Act violations. On December 4, 2008, the United States District Court for the Northern District
of Illinois granted our motion to dismiss the claims alleging business disparagement and Lanham Act violations but denied our motion to dismiss the claims related to the alleged violation of certain monopolization laws. On August 25, 2009, we
filed a motion for preliminary injunctive relief seeking to enjoin Peerless Network, LLC and Peerless Network of Illinois, LLC from providing certain tandem transit services. The preliminary injunction hearing is scheduled for November 30, 2009
and December 1, 2009. The court is not required to rule on our request for injunctive relief by any specific date. Additionally, the parties continue to conduct discovery on our claims and the defendants remaining counterclaims. We
believe that the defendants remaining allegations have no merit and intend to vigorously defend ourselves against these remaining counterclaims.



|Item 1A. | Risk Factors
|-------- | ------------

Set forth
below is a discussion of the material changes in our risk factors as previously disclosed in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2008.



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Regulatory developments could negatively impact our business.

The communications services industry is extensively regulated by the federal and state governments. While the pricing of our services is
generally not heavily regulated by the Federal Communications Commission, or FCC, or state utility agencies, these agencies have greater regulatory authority over the pricing of incumbent local exchange carriers, or ILECs, tandem transit and
access services, which generally sets the benchmark for the prices of the competitive services that we offer. To the extent that the ILEC transit or access rates are reduced or capped, it could have an adverse impact on us, as we would likely be
forced to reduce our rates in order to compete with the ILEC or other competitors.

Local Tandem Transit Service

Some state governments and their regulatory authorities assert jurisdiction over the provision of local tandem transit
services, particularly the ILECs provision of the service. Various state regulatory authorities have initiated proceedings to examine the regulatory status of transit services. Some states have taken the position that transit service is an
element of the transport and termination of traffic services that incumbent ILECs are required to provide at rates based on incremental costs under the Telecommunications Act, while other states have ruled that the Telecommunications Act
does not apply to these services. For example:



| |  |  | In Michigan in 2005, the Michigan Public Service Commission revised the maximum allowable rate that AT&T could charge for transit service in
Michigan based on AT&Ts total element long run incremental cost, or TELRIC, which was significantly below the rate previously charged by AT&T (previously SBC Communications). This decision caused us to reduce the rate we charged for
our transit service and had a significant impact on the profitability of our service in Michigan.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In December 2008, the United States District Court for the District of Nebraska held that the Public Service Commission of Nebraska was correct in
determining that the ILEC must provide transit service under the Telecommunications Act and that the Nebraska PSC did not err in ordering the ILEC to provide the service at TELRIC based rates.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Additionally, a declaratory action was commenced with the Connecticut Department of Public Utility Control (the DPUC) pursuant to which a
competitive carrier requested that the DPUC order the ILEC to reduce its transit rate to a cost based rate similar to a rate offered by that ILEC in a different state or to a rate justified in a separate cost proceeding. The DPUC recently ordered
the ILEC to implement an interim rate that is based on its costs for transit plus a 35% mark-up. We anticipate that the ILEC will appeal the DPUC ruling to the appropriate federal court.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Telecommunications Regulatory Board (the Board) of Puerto Rico, where we recently began offering our service, recently determined that
the ILEC must provide transit service at a cost based rate, and ordered the ILEC to submit a cost study in order to support the development of a cost based rate. In addition to submitting the cost study, on September 23, 2009, the ILEC filed a
motion seeking administrative review of the Boards order in the Puerto Rico appellate court. In its motion, the ILEC alleges that the Boards order constitutes a regulation and as such was not approved as required by provisions of
Puerto Ricos Uniform Administrative Law.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If as a result of any of these current proceedings or a
different proceeding, the applicable ILEC is required to reduce or limit the rate it charges for transit service, we would likely be forced to reduce our rate or risk losing customer traffic, which could have an adverse affect on our business,
financial condition and operating results.

The FCC currently does not regulate the local transit services we offer. However,
in 2001 the FCC initiated a proceeding to address intercarrier compensation issues, such as rules that govern the amount that one carrier pays to another carrier for access to the others network. As part of that docket, on July 24, 2006,
a group of large and rural local exchange carriers, or LECs, filed a proposal for intercarrier compensation reform at the FCC called the Missoula Plan, which includes provisions regarding local transit services. Under the Missoula Plan, local
transit service would be provided at a rate not to exceed $0.0025 per minute of use for the first four years of the plan, and then increase with inflation. This rate is lower than the rates charged by the ILECs or by us in several of the markets in
which we currently operate. Although the FCC has not yet issued a ruling in this docket that directly affects us, on November 5, 2008, the FCC issued for public comment two alternative proposed orders that comprehensively address intercarrier
compensation reform. In these proposed orders, the FCC asserts legal authority to regulate comprehensively over all intercarrier compensation rates, including intrastate access and local transit charges.

The two proposed orders each request public comment on whether the modifications to the rules governing intercarrier compensation would
necessitate any changes to the rules that govern transit traffic. If the FCC does make such changes, whether independently or as part of the intercarrier compensation docket, such changes could have a material and adverse effect on our business. For
example, the FCC could change the pricing of transit traffic, including lowering the rate, freezing the rate or establishing uniform rates, any of which could have a material adverse effect on our business, financial condition and operating results.
In addition, from time to time, carriers that we connect with have requested that we pay them to terminate traffic, and any new rules could address those rights or obligations. If the FCC determines that a terminating carrier may have the right to
receive payments from us for terminating traffic, it could have a material adverse effect on our business, financial condition and operating results.



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Additionally, each proposed order contains provisions that indirectly affect local transit
traffic. For example, under current law, the originating carrier is typically responsible for paying the terminating carrier certain terminating charges, such as reciprocal compensation charges, for access to the terminating
carriers network. As a result, under such law, we, as the intermediate transit provider, are not responsible for paying such terminating charges to a terminating carrier in connection with the transit services we offer. Each draft order,
however, requires that we, as the transit provider, could be responsible for paying the highest lawful terminating charge to a terminating carrier if the terminating carrier receives insufficient information for the terminating carrier to bill the
originating carrier for that traffic. These amounts could be significantly larger than the rate we charge for providing the transit service associated with that traffic. Although the proposed orders also allow us to recover from the originating
carrier the same amount that we paid to the terminating carrier, in such an instance we would be faced with credit risks associated with collecting such amounts from the originating carrier, as well as possible disputes with both originating and
terminating carriers regarding the appropriate amount due. In this event, if we were unable to recover amounts we paid to a terminating carrier or became involved in distracting and costly disputes with the originating carrier and/or the terminating
carrier over the amount due, we could experience a material adverse effect on our business. Moreover, the alternative proposed orders may result in changes to the demand for our services or otherwise adversely impact our business, financial
condition, operating results and growth opportunities in a manner that we have not presently identified.

Access Services

We recently began providing access services using our tandem switches. Access services are provided as a part of the
origination and termination of long distance calls. The FCC generally regulates interstate access services and the states regulate intrastate access services. The FCC also has certain rights to regulate intrastate access services, and, as part of
the intercarrier compensation draft orders discussed above, proposes to significantly reduce both interstate and intrastate terminating access charges over a ten year transition period. As part of the same draft orders, the FCC also proposes to
eliminate entirely certain originating interstate and intrastate access charges. Various states are also conducting proceedings to determine whether to mandate any decreases to existing intrastate access charges. If the FCC, whether independent of
or as part of the intercarrier compensation docket described above, or any state lowers these access charges, such change could have a material and adverse effect on our business, financial condition, operating results or growth opportunities.

As communications technologies and the communications industry continue to evolve, the statutes governing the communications
industry or the regulatory policies of the FCC, state legislatures or agencies or local authorities may change. If this were to occur, including pursuant to any of the proceedings discussed above, the demand and pricing for our services could change
in ways that we cannot easily predict and our revenues could materially decline. These risks include the ability of the federal government, including Congress or the FCC, or state legislatures or agencies, or local authorities to:



| |  |  | increase regulatory oversight over the services we provide;
| | - |  | -----------------------------------------------------------



| |  |  | adopt or modify statutes, regulations, policies, procedures or programs that are disadvantageous to the services we provide, or that are inconsistent
with our current or future plans, or that require modification of the terms of our existing contracts, including reducing the rates for our services;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | adopt or modify statutes, regulations, policies, procedures or programs in a way that causes changes to our operations or costs or the operations of
our customers, including the pricing of our services to our customers;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | adopt or modify statutes, regulations, policies, procedures or programs in a way that causes a decrease in the amount of traffic our customers exchange
with us or causes a change to our customers traffic mix, which results in our customers using, on average, lower priced services; or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | increase or impose new or additional taxes or surcharges that are disadvantageous to the services we provide or cause a decrease in the amount of
traffic our customers deliver to us.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We cannot predict when, or upon what terms and conditions, further
federal, state or local regulation or deregulation might occur or the effect future regulation or deregulation may have on our business. Any of these government actions could have a material adverse effect on our business, prospects, financial
condition and operating results.

We face competition from the traditional ILECs and increasing competition from certain other providers
such as Level 3 Communications, Peerless Networks and Hypercube and expect to compete with new entrants to the tandem services market.

We face competition from the traditional ILECs, certain other providers such as Level 3 Communications, Peerless Networks and Hypercube, and expect to compete with new entrants to the tandem services
market. Competition has recently intensified causing



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us to lose some traffic as well as reduce certain rates we charge our customers in various markets, including with respect to our major customers. We expect competition to intensify in the
future, including as a result of the adoption of IP-based switching by telecommunications carriers, which is likely to increase competition from direct connections. See The market for our services is competitive and increased adoption of IP
switching technologies could increase the competition we face from direct connections in our Annual Report on Form 10-K for the year ended December 31, 2008. Certain of our current and potential competitors have significantly more
employees and greater financial, technical, marketing, research and development, intellectual property development and protection and other resources than us. Also, some of our current and potential competitors have greater name recognition that
they can use to their advantage. Our competitors may charge rates that are below the rates we charge. In addition, our competitors could lower their rates or bundle other services with their transit or access services to compete with us or be able
to respond more quickly to new or emerging technologies and changes in customer requirements than we can. Furthermore, changes in switching technology have lowered the cost of entry into our business which could promote additional competition.
Existing or increased competition as described above could result in fewer customer orders, reduced revenues, reduced gross margins and loss of market share, any of which could have a material and adverse effect on our business, prospects, financial
condition and operating results.

In addition to the other information set forth in this report, you should carefully consider
the description of the risks and uncertainties associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and in Part II, Item 1A of our Quarterly
Reports on Form 10Q for the quarters ended March 31, 2009 and June 30, 2009. You should carefully consider such risks and uncertainties, together with the other information contained in this report and in our other public filings.

If any of such risks and uncertainties actually occurs, our business, financial condition or operating results could differ
materially from the plans, projections and other forward-looking statements included in the section titled Managements Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report and in our
other public filings. In addition, if any of these risks and uncertainties, or if any other risks and uncertainties, actually occurs, our business, financial condition or operating results could be harmed substantially, which could cause the market
price of our stock to decline, perhaps significantly.



|Item 6. | Exhibits
|------- | --------

(a) Exhibits



|             |  |                                                                                                                                
|------------ |  | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit 31.1 |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                            
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                            
|             | 
|Exhibit 32.1 |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.



|                       |  |                      |  |                                                                                       
|---------------------- |  | -------------------- |  | --------------------------------------------------------------------------------------
|                       |  | NEUTRAL TANDEM, INC.
|                       |  |                     
|Date: November 5, 2009 |  | By:                  |  | /S/    RIAN
WREN                                                                      
|                       |  |                      |  | Rian Wren, Chief Executive Officer (Principal Executive
Officer)                      
|                       |  |                     
|Date: November 5, 2009 |  | By:                  |  | /S/    ROBERT
JUNKROSKI                                                               
|                       |  |                      |  | Robert Junkroski, Chief Financial Officer (Principal Financial and Accounting Officer)



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