UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)


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 000-49636





VIKING
SYSTEMS, INC.


(Exact
name of registrant as specified in its charter)





Delaware
            
            86-0913802(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer
              Identification
      No.)





134 Flanders Road,
Westborough, MA 01581


(Address
of principal executive offices) (Zip Code)





(508)
366-3668


(Registrant’s
telephone number, including area code)





Indicate
by check mark 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 xNO  ̈





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 o





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
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





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





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





The
registrant had 42,715,110 shares of common stock, $0.001 par value per share,
outstanding as of October 30, 2009.













FORM
10-Q





FINANCIAL
STATEMENTS AND SCHEDULES


VIKING
SYSTEMS, INC.





For
the Quarter ended September 30, 2009





PART I - FINANCIAL
INFORMATION





Form
      10-QItem
      1.
            Financial
      Statements (unaudited):Balance
      Sheets at  September 30, 2009 and December 31,
    2008
            2Statements
      of Operations for the Three and Nine  Months Ended September 30,
      2009 and 2008
            3Statements
      of Cash Flows for the Nine Months Ended September 30, 2009 and
      2008
            4-5Notes
      to Financial Statements
            6-10Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
            11-15Item
      3
            Quantitative
      and Qualitative Disclosure About Market Risk
            16Item
      4T.
            Controls
      and Procedures
            16





PART II - OTHER
INFORMATION





Item
      1.
            Legal
      Proceedings
            17Item
      1A.
            Risk
      Factors
            17-21Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            21Item
      3.
            Defaults
      Upon Senior Securities
            21Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            21Item
      5.
            Other
      Information
            21Item
      6.
            Exhibits
            22-23










PART
I - FINANCIAL INFORMATION




ITEM
1.   FINANCIAL STATEMENTS




VIKING
SYSTEMS, INC.


Balance
Sheets - Unaudited





September
      30,
            
            
            December
      31,Assets
            
            2009
            
            
            2008Current
      assets:Cash
      and cash equivalents
            
            $
            214,510
            
            
            $
            168,767Accounts
      receivable, net
            
            
            621,135
            
            
            
            837,229Inventories,
      net
            
            
            1,869,458
            
            
            
            2,104,764Prepaid
      expenses
            
            
            50,867
            
            
            
            151,048Total
      current assets
            
            
            2,755,970
            
            
            
            3,261,808Property
      and equipment, net
            
            
            55,249
            
            
            
            223,609Intangible
      assets, net
            
            
            157,500
            
            
            
            210,000Total
      assets
            
            $
            2,968,719
            
            
            $
            3,695,417Liabilities
      and Stockholders' EquityCurrent
      liabilities:Accounts
      payable
            
            $
            1,174,668
            
            
            $
            1,432,460Accrued
      liabilities
            
            
            772,873
            
            
            
            794,219Deferred
      revenue
            
            
            175,005
            
            
            
            51,254Capital
      lease obligations
            
            
            -
            
            
            
            31,821Total
      current liabilities
            
            
            2,122,546
            
            
            
            2,309,754Commitments
      and contingenciesPreferred
      Stock, 25,000,000 shares authorizedSeries
      B redeemable preferred stock, $0.001 par value; No shares outstanding at
      September 30, 2009 and December 31, 2008
            
            
            -
            
            
            
            -Stockholders’
      Equity:Common
      stock, $0.001 par value, 400,000,000 shares authorized; and 42,715,110
      issued and outstanding at September 30, 2009 and  December 31,
      2008
            
            
            42,715
            
            
            
            42,715Additional
      paid-in capital
            
            
            26,909,786
            
            
            
            26,566,607Accumulated
      deficit
            
            
            (26,106,328
            )
            
            
            (25,223,659
            )Total
      stockholders' equity
            
            
            846,173
            
            
            
            1,385,663Total
      liabilities and stockholders' equity
            
            $
            2,968,719
            
            
            $
            3,695,417








The
accompanying notes are an integral part of the interim financial
statements.




2




VIKING
SYSTEMS, INC.


Statements
of Operations - Unaudited





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Sales,
      net
            
            $
            1,995,614
            
            
            $
            1,585,826
            
            
            $
            5,149,504
            
            
            $
            4,447,528Cost
      of salesCost
      of goods sold
            
            
            1,508,042
            
            
            
            1,261,819
            
            
            
            3,839,690
            
            
            
            3,800,380Inventory
      valuation charge
            
            
            -
            
            
            
            372,440
            
            
            
            -
            
            
            
            372,440Total
      cost of sales
            
            
            1,508,042
            
            
            
            1,634,259
            
            
            
            3,839,690
            
            
            
            4,172,820Gross
      profit  (loss)
            
            
            487,572
            
            
            
            (48,433
            )
            
            
            1,309,814
            
            
            
            274,708Operating
      expenses:Selling
      and marketing
            
            
            174,252
            
            
            
            278,927
            
            
            
            685,226
            
            
            
            1,072,491Research
      and development
            
            
            121,951
            
            
            
            183,711
            
            
            
            402,751
            
            
            
            613,917General
      and administrative
            
            
            384,685
            
            
            
            533,486
            
            
            
            1,218,700
            
            
            
            2,536,060Total
      operating expenses
            
            
            680,888
            
            
            
            996,124
            
            
            
            2,306,677
            
            
            
            4,222,468Operating
      loss
            
            
            (193,316
            )
            
            
            (1,044,557
            )
            
            
            (996,863
            )
            
            
            (3,947,760
            )Other
      income (expense):Interest
      income
            
            
            199
            
            
            
            1,432
            
            
            
            949
            
            
            
            19,503Interest
      expense
            
            
            (2,760
            )
            
            
            (1,272
            )
            
            
            (3,815
            )
            
            
            (3,052
            )Loss
      on recapitalization transaction
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,703,776
            )License
      fee
            
            
            -
            
            
            
            1,000,000
            
            
            
            115,000
            
            
            
            1,000,000Other
      income
            
            
            -
            
            
            
            798
            
            
            
            2,060
            
            
            
            272,298Gain
      on derivative liability
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            307,061Total
      other income (expense)
            
            
            (2,561
            )
            
            
            1,000,958
            
            
            
            114,194
            
            
            
            (1,107,966
            )Net
      loss
            
            $
            (195,877
            )
            
            $
            (43,599
            )
            
            $
            (882,669
            )
            
            $
            (5,055,726
            )Net
      loss per share - basic and diluted
            
            $
            (0.00
            )
            
            $
            (0.00
            )
            
            $
            (0.02
            )
            
            $
            (0.12
            )Weighted
      average shares - basic and diluted
            
            
            42,715,110
            
            
            
            42,556,610
            
            
            
            42,715,110
            
            
            
            42,105,975








The
accompanying notes are an integral part of the interim financial
statements.




3




VIKING
SYSTEMS, INC.


Statements
of Cash Flows - Unaudited





Nine
      Months Ended
              September
      30,2009
            
            
            2008Cash
      flows from operating activities:Net
      loss
            
            $
            (882,669
            )
            
            $
            (5,055,726
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
            
            
            218,030
            
            
            
            386,179Stock
      based compensation expense
            
            
            343,179
            
            
            
            965,857Gain
      on derivative liability
            
            
            -
            
            
            
            (307,061
            )Loss
      on recapitalization transaction
            
            
            -
            
            
            
            2,703,776Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            216,094
            
            
            
            442,470Inventories,
      net
            
            
            249,147
            
            
            
            (357,586
            )Prepaid
      expenses
            
            
            100,181
            
            
            
            (126,321
            )Other
      current assets
            
            
            -
            
            
            
            108,512Accounts
      payable
            
            
            (257,792
            )
            
            
            (444,349
            )Accrued
      expenses
            
            
            (21,346
            )
            
            
            (535,497
            )Deferred
      revenue
            
            
            123,751
            
            
            
            (203,619
            )Net
      cash provided by (used in) operating activities
            
            
            88,575
            
            
            
            (2,423,365
            )Cash
      flows from investing activities:Purchase
      of property and equipment
            
            
            (11,011
            )
            
            
            (80,755
            )Net
      cash used in investing activities
            
            
            (11,011
            )
            
            
            (80,755
            )





Cash
      flows from financing activities:Net
      proceeds from issuance of common stock
            
            
            -
            
            
            
            2,589,905Repayment
      of capital lease obligations
            
            
            (31,821
            )
            
            
            (31,408
            )Net
      cash (used in) provided by financing activities
            
            
            (31,821
            )
            
            
            2,558,497Net
      increase in cash and cash equivalents
            
            
            45,743
            
            
            
            54,377Cash
      and cash equivalents at beginning of period
            
            
            168,767
            
            
            
            317,098Cash
      and cash equivalents at end of period
            
            $
            214,510
            
            
            $
            371,475Supplemental
      disclosure of cash flow information:Cash
      paid during the period for:
            
            
            -
            
            
            
            -Interest
            
            $
            3,815
            
            
            $
            3,039Income
      taxes
            
            $
            -
            
            
            $
            -








The
accompanying notes are an integral part of the interim financial
statements.





4





VIKING
SYSTEMS, INC.


Statements
of Cash Flows - Unaudited  (continued)





Non-cash,
investing and financing activities:





There
were no non-cash investing and financing activities during the nine months ended
September 30, 2009.





During
the nine months ended September 30, 2008, the Company:





●
            Issued
      22,400,020 shares of common stock in exchange for all outstanding
      convertible debentures and related accrued interest and liquidated
      damages.





●
            Issued
      4,197,849 shares of common stock in exchange for all outstanding Preferred
      Stock and related accrued dividends, interest on unpaid dividends and
      liquidated damages.





●
            Issued
      warrants to purchase 11,200,011 shares of the Company’s common stock to
      the former convertible debenture holders in exchange for their then
      outstanding warrants to purchase 443,141 shares of common
      stock.





●
            Issued
      warrants to purchase 2,098,027 shares of the Company’s common stock to the
      former Preferred Stockholders in exchange for their then outstanding
      warrants to purchase 666,667 shares of common
  stock.





The
accompanying notes are an integral part of the interim financial
statements.





5




1.           INTERIM
FINANCIAL STATEMENTS





The
accompanying unaudited interim financial statements of Viking Systems, Inc.
(“Viking” or the “Company”) have been prepared in accordance with U.S. generally
accepted accounting principles for interim financial information and the
instructions to Form 10-Q and Article 8 of Regulation S-X. In the opinion
of management,  the interim financial statements reflect all
adjustments necessary to make the financial statements presented not
misleading. The balance sheet as of December 31, 2008 was derived from the
Company's audited financial statements. The financial statements and notes
thereto should be read in conjunction with the financial statements and notes
for the year ended December 31, 2008, included in Viking's annual report on
Form 10-K for the year ended December 31, 2008,  which was filed on
April 15, 2009 with the Securities and Exchange Commission. The results of
operations and cash flows for the periods ended September 30, 2009 are not
necessarily indicative of results to be expected for the fiscal year ending
December 31, 2009.





2.           LIQUIDITY





The
accompanying financial statements have been prepared on a going concern basis,
which contemplates, among other things, the realization of assets and the
satisfaction of liabilities in the ordinary course of
business.  During the nine months ended September 30, 2009, the
Company incurred a net loss of $882,669.  For the year ended December
31, 2008, the Company recorded a net loss of $5,752,057 and cash used in
operating activities was $2,615,399.  As of September 30, 2009, the
Company had $214,510 of cash and cash equivalents and a net working capital
balance of $633,424.





Management
believes that the Company’s existing cash resources, combined with projected
cash flows from operations may not be sufficient to execute its business plan
and continue operations for the next twelve months.  Management has
taken steps to reduce the Company’s operating expenses, and continues to
implement changes in its strategic direction aimed at achieving profitability
and positive cash flow.





In
October 2009, the Company received an order from the U.S. Army for its
proprietary 3Di vision systems totaling $897,400. The Company delivered these
systems during October 2009 and anticipates payment in full in November
2009.   No significant cash outlay is required to fulfill this
order as the Company has been carrying sufficient inventory in anticipation of
this order during 2009.





In
addition, management continues to explore various strategic alternatives,
including business combinations, private placements of debt or equity securities
and strategic licensing or other arrangements. In November 2008, the
Company engaged an investment banking firm to assist management in exploring
business combinations and/or raising additional capital.   A number of
third parties executed confidentiality agreements with the Company during this
process;  Over the past nine months the Company has had and, in some
instances, continues to have varying levels of discussion with certain of these
parties.    However, absent expedited developments related
to a potential sale of the Company, Viking plans to seek  financing of
$2 million to $3 million to fund the development  and launch
of  the Company’s “Next Generation” 3DHD
system,  anticipated 2010 operating losses and working capital
needs.  The Company may not be successful in executing a business
combination or in obtaining additional financing on acceptable terms, on a
timely basis, or at all, in which case, the Company may be forced to make
further cut backs, or cease operations.  The financial statements do
not include any adjustments that might be necessary should the Company be unable
to continue as a going concern




6





3.           LOSS
PER SHARE





The
computation of basic and diluted loss per common share is computed using the
weighted average number of common shares outstanding during the
year.





Due to
the net losses for the three and nine month periods ended September 30, 2009 and
September 30, 2008, potentially dilutive securities have been excluded in the
calculation of diluted loss per share because their inclusion would be
anti-dilutive. Accordingly, basic and diluted loss per share are the same within
each respective period.





The
following potentially dilutive common shares were excluded from the calculation
of diluted net loss per common share because their effect was antidilutive for
the periods presented:





September 30,
              2009
            
            September 30,
              2008Warrants
            
            27,913,631
            
            
            27,985,019Stock
      Options
            
            7,203,940
            
            
            6,374,440Total
            
            35,117,571
            
            
            34,359,459





4.           INVENTORY





Details
of our inventory account balances are as follows:





September
      30,
              2009
            
            
            December
      31,
              2008Inventories:Parts
      and supplies
            
            $
            1,144,700
            
            
            $
            1,208,720Work-in-progress
            
            
            322,195
            
            
            
            426,779Finished
      goods
            
            
            858,013
            
            
            
            945,816Valuation
      reserve
            
            
            (455,450
            )
            
            
            (476,551
            )$
            1,869,458
            
            
            $
            2,104,764





5.           ACCRUED
LIABILITIES





Accrued
liabilities consist of the following:





September
      30,
              2009
            
            
            December
      31,
              2008Employee
      and director compensation
            
            $
            447,883
            
            
            $
            433,371Registration
      delay fees
            
            
            161,574
            
            
            
            161,574Professional
      and consulting fees
            
            
            76,338
            
            
            
            88,918Other
      accrued expenses
            
            
            87,078
            
            
            
            110,356$
            772,873
            
            
            $
            794,219





6.           LICENSE
AGREEMENT





In March
2009, the Company licensed one of its patents to a third party through September
2009.  The license is exclusive and is for use outside the medical
products field.  The third party had previously licensed this patent
through December 2006.  The license fee of $115,000 is included in
other income for the nine months ended September 30, 2009.





7.           STOCK-BASED
COMPENSATION





During
the quarter ended March 31, 2008, shareholders approved  the Viking
Systems, Inc. 2008 Equity Incentive Plan (the “2008 Equity Plan”), and the
Viking Systems, Inc. 2008 Non-Employee Directors’ Stock Option Plan (the
“Directors’ Plan,” ). The maximum number of shares that may be issued pursuant
to the 2008 Equity Plan is 6,720,000 shares plus such number of shares that are
issuable pursuant to awards outstanding under the 2004 Plan as of the effective
date and which would have otherwise reverted to the share reserve of the 2004
Plan. We have reserved a total of 1,500,000 shares of our common stock for
issuance under the Directors’ Plan.  During the nine months ended
September 30, 2009, 700,000 options were granted under the 2008 Equity Plan and
150,000 options were granted under the Directors’ Plan.  During the
nine months ended September 30, 2008, 6,715,000 stock options were granted under
the 2008 Equity Plan and 150,000 stock options were granted under the Directors’
Plan.




7




The
Company measures the cost of employee services received in exchange for an award
of equity instruments based on the grant-date fair value of the award. That cost
is recognized over the period during which an employee is required to provide
service in exchange for the award - the requisite service period. The Company
determines the grant-date fair value of employee share options using the
Black-Scholes option-pricing model.





During
the three months ended September 30, 2009 and 2008, the Company recorded
$113,161 and $120,533 respectively and during the nine months ended September
30, 2009 and 2008, the Company recorded $343,179 and
$965,857  respectively, in non-cash stock-based compensation expense.
As of September 30, 2009, there was approximately $792,000 in total unrecognized
compensation costs related to unvested options, which is expected to be
recognized over a weighted average period of approximately 2.25
years.





During
the nine months ended September 30, 2009, 850,000 stock options were granted
with a weighted average exercise price of $0.019 per share based on the quoted
market price on the day of grant. The valuation of such stock options as
determined using the Black-Scholes valuation model was approximately $13,000.
The fair value of stock options granted during the nine months ended September
30, 2008 was estimated using the Black-Scholes model with the following
assumptions: volatility of 133%, life of 5-7 years, risk-free interest rate
of 3.33%, and expected dividend yield of 0%. Volatility is based on the
historical volatility of the Company's common stock. The life of employee stock
options is based on the average of the vesting period and contractual life. The
risk free interest rate is based on U.S. Treasury constant maturity rate for the
expected life of the stock option.





Using the
assumption described above, the 6,865,000 stock options granted during the nine
months ended September 30, 2008 were valued at
$1,779,528.





The
following table summarizes the stock option activity during the nine months
ended September 30, 2009:





Number
      of
              Shares
            
            
            Weighted
      - Average
              Exercise
              Price
            
            
            Weighted
      -Average Remaining
              Contractual
              Life
              (in
      years)Options
      outstanding December 31, 2008
            
            
            6,354,440
            
            
            $
            0.58
            
            
            
            9.11Granted
            
            
            850,000
            
            
            $
            0.019
            
            
            
            9.73Cancelled
      or expired
            
            
            500
            
            
            $
            17.50
            
            
            
            -Options
      outstanding September 30, 2009
            
            
            7,203,940
            
            
            $
            0.52.
            
            
            
            8.53Options
      exercisable at September 30, 2009
            
            
            3,890,778
            
            
            $
            0.73
            
            
            
            8.33





During
the nine months ended September 30, 2008, nine employees surrendered 79,000
previously issued stock options. As a result, the total amount of shares
issuable under 2008 Equity Plan increased by 79,000.   In
connection with the surrender of stock options, during nine months ended
September 30, 2008 the Company recognized the remaining non-cash stock option
compensation of $410,258 related to these stock options.





8.           WARRANTS
TO PURCHASE COMMON STOCK





The
following table summarizes warrant activity during the nine months ended
September 30, 2009:





Shares
            
            
            Range
      of
              Exercise
              Price
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Weighted
              Average
              Remaining
              Contractual
              LifeWarrants
      outstanding December 31, 2008
            
            
            27,985,020
            
            
            $
            0.18-0.35
            
            
            $
            0.18
            
            
            
            4.0Expired
            
            
            (71,389
            )
            
            $
            0.35
            
            
            $
            0.35
            
            
            
            -Exercised
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Outstanding
      September 30, 2009
            
            
            27,913,631
            
            
            
            0.18-0.35
            
            
            
            0.18
            
            
            
            3.25




8





9.           RECENT
ACCOUNTING PRONOUNCEMENTS




With the
exception of those discussed below, there have been no recent accounting
pronouncements or changes in accounting pronouncements during the three and nine
months ended September 30, 2009, as compared to the recent accounting
pronouncements described in the Company’s Annual Report on Form 10-K for the
fiscal year ended December 31, 2008, that are of significance, or potential
significance to the Company.




Adopted
Accounting Pronouncements




As of
September 2009, the Company adopted Financial Accounting Standards Board
(“FASB”) Accounting Standards Codification (“ASC” or the “Codification”) 105-10
(formerly FASB Statement No. 168“FASB Accounting Standards
Codification  and the Hierarchy of Generally Accepted Accounting
Principles). This standard establishes only two levels of U.S. generally
accepted accounting principles (“GAAP”), authoritative and nonauthoritative. The
Codification  became the single source of authoritative,
nongovernmental GAAP, except for rules and interpretive releases of the
SEC, which are sources of authoritative GAAP for SEC registrants. All other
non-grandfathered, non-SEC accounting literature not included in the
Codification became nonauthoritative. ASC 105-10 does not change previously
issued GAAP, but reorganizes GAAP into Topics.  In circumstances where
previous standards require a revision, the FASB will issue an Accounting
Standards Update (“ASU”) on the Topic.  Our adoption of ASC 105-10 did
not have any impact on the Company’s financial statements.




In June
2008, the FASB ratified the consensus reached on the Emerging Issues Task Force
(“EITF”) abstract titled “Determining Whether an Instrument (or Embedded
Feature) Is Indexed to an Entity’s Own Stock”. As codified in ASC 815-40,
“Derivatives and Hedging-Contracts in Entity’s Own Equity”(formerly EITF Issue No.
07-5),this guidance
provides a new two-step model to be applied in determining whether a financial
instrument or an embedded feature is indexed to an issuer’s own stock and thus
able to qualify for the scope exception under ASC 815-10-15-2. The adoption of
this guidance effective January 1, 2009 did not have a material impact on the
Company’s financial statements.




In
February 2008, the FASB issued updated guidance as codified in ASC 820-10, “Fair
Value Measurements and Disclosures” (formerly FASB Staff
Position FAS 157-2),  that delayed the effective date of fair value
measurements accounting for all non-financial assets and non-financial
liabilities, except for items that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually), until the
beginning of the first quarter of fiscal 2009. These include goodwill and other
non-amortizable intangible assets. The adoption of this guidance effective
January 1, 2009, did not have any impact on the Company’s financial
statements.




In April
2008, the FASB issued updated guidance regarding the determination of the useful
life of intangible assets. As codified in ASC 350-30-35, “Intangibles-Goodwill
and Other”(formerly  FASB
Staff Position FAS 142-3), this guidance amends the factors considered in
developing renewal or extension assumptions used to determine the useful life of
a recognized intangible asset under intangibles accounting. It also requires
expanded disclosure related to the determination of intangible asset useful
lives.  The adoption of this guidance effective January 1, 2009 did
not have any impact on the Company’s financial statements.




In April
2009, the FASB issued updated guidance, as codified in ASC 820-10-65, “Fair Value Measurements and
Disclosures”(formerly FSP SFAS
No. 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”), for estimating fair value when the volume
and level of activity for the asset or liability have significantly decreased in
accordance with fair value accounting.  This guidance also includes
identifying circumstances that indicate a transaction is not orderly, and
emphasizes that even if there has been a significant decrease in the volume and
level of activity for the asset or liability and regardless of the valuation
technique(s) used, the objective of a fair value measurement remains the same.
The adoption of this guidance during the quarter ended June 30, 2009 did not
have a material effect on the Company’s financial statements.




9




In April
2009, the FASB issued updated guidance, as also codified in ASC 825-10-65, “Fair
Value Measurements and Disclosures”(formerly FSP FAS
No. 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial
Instruments” ) which requires increased disclosures about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. The adoption of this guidance during
the quarter ended June 30, 2009 did not have a material effect on the Company’s
financial statements.




In May
2009, the FASB issued updated guidance, codified as ASC 855-10, “Subsequent
Events”,(formerly
SFAS No. 165) that establishes general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. This guidance
modifies the names of the two types of subsequent events either as recognized
subsequent events (previously referred to in practice as Type I subsequent
events) or non-recognized subsequent events (previously referred to in practice
as Type II subsequent events). In addition, this guidance requires the
disclosure of the date through which subsequent events have been evaluated. The
adoption of this guidance during the quarter ended June 30, 2009 did not have
any impact on the Company’s financial statements.




The
Company has evaluated subsequent events that occurred after September 30, 2009,
through November 6, 2009, the date the Company’s financial statements were
issued. During this period the Company did not have any material recognized
or unrecognized subsequent events that required recognition or disclosure in our
September 30, 2009 financial statements.




New
Accounting Pronouncements




In
September 2009, the FASB issued ASU. 2009-13, “Multiple-Deliverable Revenue
Arrangements—a consensus of the FASB Emerging Issues Task Force” (“ASU
2009-13”). ASU 2009-13 updates the existing multiple-element revenue
arrangements guidance currently included under ASC 605-25 (formerly EITF 00-21),
and primarily  provides two significant changes: 1) eliminates the
need for objective and reliable evidence of the fair value for the undelivered
element in order for a delivered item to be treated as a separate unit of
accounting, and 2) eliminates the residual method to allocate the arrangement
consideration. In addition, this guidance  expands the disclosure
requirements for revenue recognition. ASU 2009-13 will be effective for the
first annual reporting period beginning on or after June 15, 2010, with
early adoption permitted provided that the revised guidance is retroactively
applied to the beginning of the year of adoption. The Company is currently
assessing the future impact of this new accounting update to its financial
statements.




10




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. You should not place undue reliance on these
forward-looking statements.  Our actual results could differ materially
from those anticipated in the forward-looking statements for many reasons,
including the risks described in our Annual Report on Form 10-K, this report and
other reports we file with the Securities and Exchange Commission. Although
we believe the expectations reflected
in the forward-looking statements are reasonable, they
relate only to events as of the date on which the statements are
made.  We do not intend to update any of the forward-looking statements
after the date of this document to conform these statements to actual results or
to changes in our expectations, except as required by law.





The
following discussion and analysis should be read in conjunction with the
Financial Statements and Notes thereto, and other financial information included
elsewhere in this quarterly report on Form 10-Q.





Overview





We are a
worldwide developer, manufacturer and marketer of visualization solutions for
complex minimally invasive surgery.  We partner with medical device
companies and healthcare facilities to provide surgeons with proprietary
visualization systems enabling minimally invasive surgical procedures, which
reduce patient trauma and recovery time.





We
manufacture two dimensional, or 2D, digital cameras that are sold to third-party
companies who sell to end users through their Original Design Manufacturer, or
ODM, programs and Original Equipment Manufacturer, or OEM,
programs.





We sell
our proprietary visualization system, (3Di Vision System) under the Viking
brand directly to hospitals and outpatient surgical centers in the United States
and outside the United States through our distributor network.  We
also sell our CardioCam/MiniCam product through these channels.





Liquidity
and Capital Resources





On
January 4, 2008, we completed execution of a Recapitalization Plan (the
“Recapitalization Plan”).   In November 2007, we received approval,
subject to finalization of certain terms and execution of final documentation,
from 100% of the stockholders of our Series B Variable Dividend Convertible
Preferred Stock (the “Preferred Stock”) and our 8% Secured Convertible
Debentures due February 23, 2009 (the “Debentures”), of the Recapitalization
Plan.  The Recapitalization Plan called for an additional investment
of $2.5 to $3.0 million (the “New Investment”) and a redistribution of our
common stock among the current holders of our common stock, Preferred Stock,
Debentures and the investors providing the New Investment.





In
consummating the Recapitalization Plan, the redistribution of our capital was
accomplished on January 4, 2008 through the following: (i) a 1 for 50 “reverse
split” of our outstanding common stock, (ii) our entry into a Recapitalization
Agreement with the applicable holders, pursuant to which the holders of the
Preferred Stock and Debentures exchanged their respective securities (including
warrants that were issued in connection with the Preferred Stock and the
Debentures) for shares of our common stock and warrants which may be exercised
for common stock; and (iii) our entry into a Securities Purchase Agreement with
those parties making the New Investment of $2.6 million pursuant to which they
were issued shares of our common stock and warrants which may be exercised for
shares of our common stock.   As part of the recapitalization, we
executed a Securities Purchase Agreement and completed a sale of 14,560,037
shares of our common stock for $0.178571 per share, or aggregate consideration
of $2,600,000, of which we received net proceeds of $2,600,000.





In
October 2007, our board of directors approved a revised strategic direction
for our Company.  This strategy included focusing on our ODM/OEM
business while significantly reducing expenses associated with our 3Di Vision
Systems business.  We continued our 3Di Vision Systems business on a
reduced basis by utilizing our independent sales representatives and our
existing distributor network.  The revised strategic direction of
October 2007 enabled us to reduce expenses, primarily associated with the 3Di
Vision Systems business, that are not expected to contribute
to positive cash flow in the near term,  including the elimination of
our U.S. direct sales force and a reduction in related clinical and marketing
expenses.





In 2008,
the board of directors re-evaluated this decision in light of our
subsequent experience and considered various modifications to the business
strategy.  The board determined to seek additional investment in our
3Di technology followed by investment in our U.S. distribution
channels.  Recent trends and events in the 3D visualization field have
further confirmed our plans.





11




However,
we cannot implement these initiatives until we either enter into a business
combination or raise substantial capital resources. In November 2008 we
engaged an investment banking firm to assist our management in exploring
business combinations and/or raising additional capital.   A number of
third parties executed confidentiality agreements with the Company during this
process; Over the past nine months the Company has had and, in some instances,
continues to have varying levels of discussion with certain of these
parties.    However, absent expedited developments related
to the sale of the Company, Viking plans to seek  financing of $2
million to $3 million to fund the development  and launch
of  the Company’s “Next Generation” 3DHD
system,  anticipated 2010 operating losses and working capital
needs.





Absent a
business combination, we believe that we may need to raise additional capital to
execute our business plan and continue our operations for the next twelve
months. Such financing may not be available on acceptable terms, or at all. We
do not have any arrangements with any bank, financial institutions or investors
to provide additional financing and there can be no assurance that any such
arrangement, if required or otherwise sought, would be available on terms deemed
to be commercially acceptable and in our best interests. If we fail to
secure such financing and we are not generating positive cash flow, we will
consider other options, including curtailing operations or seeking bankruptcy
protection.





Since our
inception, we have financed our operations principally through private sales of
equity securities and convertible debt. From January 1, 2004
through September 30, 2009, we have raised net proceeds of $10,750,000
through the sale of common and preferred stock in private placements and
approximately $13,600,000 through the issuance of convertible notes and
debentures. As of September 30, 2009, we had cash of $214,510.





Net cash
provided by operating activities for nine months ended September 30, 2009 was
$88,575.  Net cash used in operating activities for the nine months
ended September 30, 2008 was $2,423,365. This improvement in cash flows
from operating activities was attributable primarily to a smaller loss for the
nine months ended September 30, 2009 combined with net cash generation during
2009 from the combined changes in inventory, accounts receivable, accounts
payable and accrued expenses compared with net cash consumed in those
combined changes during the same period in 2008.





Net cash
used in financing activities was $31,821 during the nine months ended September
30, 2009 compared with net cash provided by financing activities of
$2,558,497 during the nine months ended September 30, 2008. The net cash
provided by financing activities in 2008 resulted from the sale of common stock
in connection with our Recapitalization Plan. We completed no such financing
activities during the nine months ended September 30, 2009.





In
October 2009, we received an order from the U.S. Army for our proprietary 3Di
vision systems totaling $897,400. We delivered these systems during October and
anticipate payment in full in November 2009.   No significant
cash outlay is required to fulfill this order as we have carried sufficient
inventory in anticipation of this order throughout 2009.





RESULTS
OF OPERATIONS





Three
and Nine Month Period Ended September 30, 2009 Compared with the Three and Nine
Month Period Ended September 30, 2008





Sales.  We
had sales of $1,995,614 for the three months ended September 30, 2009 and of
$1,585,826 for the three months ended September 30, 2008, representing an
increase of 26%.   For the nine months ended September 30 2009,
sales increased 16% to $5,149,504 as compared with the same period in the prior
year.  The increase in sales during the quarter ended September 30,
2009 was due to increased sales of approximately $590,000 of a proprietary
visualization system designed for and distributed by one specific customer as
they elected to increase inventory levels of such product. Sales to this
customer increased by approximately $1,210,000 during the nine months ended
September 30, 2009 compared with the same period in the prior year.





Partially
offsetting this increased revenue was a decrease in revenue recognized
associated with a third party development contract for 3D vision
products.  Revenue under such arrangement is recognized using the
percent completion method.  Due to the contract nearing completion,
revenue recognized related to this arrangement decreased approximately $156,000
during the quarter ended September 30, 2009 as compared with the same period in
the prior year and decreased approximately $408,000 during the nine months ended
September 30, 2009 as compared to the same period in 2008.





Sales to
individual customers exceeding 10% of revenues in the three and nine months
ended September 30, 2009 were to three customers who accounted for 49%, 20% and
17% and 37%, 24% and 15% of revenues, respectively.




12




Gross
Profit. Gross profit was $487,572 or 24.4% of sales for the three months
ended September 30, 2009 compared to a gross loss of $48,433 for the three
months ended September 30, 2008, representing an increase
of $536,005.   For the nine months ended September 30, 2009
gross profit was $1,309,814 or 25.4% of sales compared with $274,708 or 6.2% of
sales for the same period in 2008.  Gross profit for both the quarter
and nine months ended September 30, 2008 were adversely impacted due to an
inventory reserve charge of $372,440 related to slow moving and obsolete
inventory.  Excluding such charge gross margin was 20.4% and 14.6%,
respectively for the three month and nine month periods ended September 30,
2008. These
increases in gross margin percentage for both periods in 2009 is due to a
favorable sales mix of higher margin products as well as higher production
volumes resulting in lower per unit manufacturing costs.





Operating
Expenses.  We incurred operating expenses of $680,888 for
the three months ended September 30, 2009 and $996,124 for the three
months ended September 30, 2008.  For the three months ended September
30, 2009 and 2008, excluding non-cash stock based compensation expense, total
operating expenses were $567,727 and $875,591, respectively, representing a
decrease of $307,864 or 35%.





We
incurred operating expenses of $2,306,677 for the nine months ended
September 30, 2009 and  $4,222,468 for the nine months ended
September 30, 2008.  For the nine months ended September 30, 2009 and
2008, excluding non-cash stock based compensation expense, total operating
expenses were $1,963,498 and $3,256,611, respectively, representing a decrease
of $1,293,113 or 40%.





This
decrease in total operating expenses for both periods is due largely to our
continued cost reduction efforts as described below.





Sales and
Marketing Expense. Sales and marketing expenses were $174,252 for the
three months ended September 30, 2009 and $278,927 for the three months ended
September 30, 2008.  Sales and marketing expenses were $685,226 for
the nine months ended September 30, 2009 and $1,072,491 for the nine months
ended September 30, 2008.  The decreases of 38% and 36%, respectively
are due to reductions in our marketing efforts, reduction in sales related
headcount, and lower depreciation expense related to demonstration equipment.
Partially offsetting the reduction for the nine month period was bad debt
expense of $57,845 in the quarter ended June 30, 2009.





Research and
Development Expense.  We had research and development expenses
of $121,951 for the three months ended September 30, 2009 and $183,711 for the
three months ended September 30, 2008, representing a decrease of $61,760.
For the nine months ended September 30, 2009 research and development expense
was $402,751 compared with $613,917, a decrease of $211,166. The decrease for
both periods occurred primarily due to the reduction of personnel focused on
research and development activities.





General and
Administrative Expense.  General and administrative expenses
include costs for administrative personnel, legal and accounting expenses and
various public company expenses. General and administrative expenses were
$384,685 for the three months ended September 30, 2009 and $533,486 for the
three months ended September 30, 2008.  During the three months ended
September 30, 2009, we recorded $113,161 related to non-cash stock option
compensation expense compared with $120,533 for the same period in
2008.  Excluding these charges, general and administrative expense
decreased $141,429.  Legal and audit expense decreased approximately
$44,563 as compared with the prior year. We also incurred lower audit
related expenses in 2009 compared with the same period in 2008.





General
and administrative expenses were $1,218,700 for the nine months ended September
30, 2009 and $2,536,060 for the nine months ended September 30,
2008.  During the nine months ended September 30, 2009, we recorded
$343,179 related to non-cash stock option compensation expense compared with
$965,857 for the same period in 2008.  Excluding these charges,
general and administrative expense decreased $694,682 or 44%. Legal and audit
expense decreased $363,926 as compared with the prior year.  Additionally,
we accrued an employee separation charge of approximately $90,000 during the
quarter ended June 30, 2008 that was not repeated in 2009.





Other Income and
Expenses.  During the nine months ended September 30, 2009,
other income and expense totaled to income of $114,194 compared with a net
charge of $1,107,966 for the same period in 2008.  During the first
quarter of 2009 we recorded $115,000 of license fee income related to the
granting of a license to use one of our patents in the nonmedical
markets.  During 2008, we recorded a charge of $2,703,776 related to
the recapitalization transaction.  This charge was partially offset by
a $1,000,000 license fee recorded in the third quarter of 2008 and the first
quarter 2008 reversal of approximately $271,000 related to accrued fees
associated with our failure to file a registration statement for common stock
and warrants issued during 2006.  Additionally, during the first
quarter of 2008, we recorded a non-cash gain on derivative liability of $307,061
related to the decrease in value of our derivative
instruments.




13




Operating
Loss Before Non-Cash Charges





A
reconciliation of net loss in accordance with U.S. generally accepted accounting
principles (GAAP) to the non-GAAP measure of operating loss before non-cash
charges is as follows:





Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      loss, as reported
            
            $
            (195,877
            )
            
            $
            (43,599
            )
            
            $
            (882,669
            )
            
            $
            (5,055,726
            )Adjustments:Total
      other (income)/expense
            
            
            2,561
            
            
            
            (1,000,958
            )
            
            
            (114,194
            )
            
            
            1,107,966Non-cash
      stock option expense
            
            
            113,161
            
            
            
            120,533
            
            
            
            343,179
            
            
            
            965,857Depreciation
      and amortization
            
            
            45,737
            
            
            
            120,977
            
            
            
            218,030
            
            
            
            386,179Operating
      loss before non-cash charges
            
            $
            (34,418
            )
            
            $
            (803,047
            )
            
            $
            (435,654
            )
            
            $
            (2,595,724
            )





Off-Balance
Sheet Arrangements





We do not
currently have any off-balance sheet arrangements or relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as special purpose entities, which are typically established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes.




Use
of Estimates and Critical Accounting Policies





This
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United
States.





The
preparation of our financial statements requires management to make estimates
and assumptions that affect reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. On an ongoing basis, management evaluates its estimates and
assumptions, including those related to inventory, income taxes, long lived
asset valuation, revenue recognition, stock-based compensation and derivative
liabilities. Management bases its estimates and judgments on historical
experience of operations and on various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.





Management
believes the following critical accounting policies, among others, will affect
its more significant judgments and estimates used in the preparation of our
Financial Statements.





Inventory.Parts and supplies inventories are stated at the lower of cost or market.
Cost is determined using the standard cost method which approximates actual
cost. Work-in-process and finished goods are stated at the lower of the
accumulated manufacturing costs or market.We
reduce the stated value of our inventory for obsolescence or impairment in an
amount equal to the difference between the cost of the inventory and the
estimated market value, based upon assumptions about future demand and market
conditions. If actual future demand or market conditions are less favorable than
those projected by management, additional reductions in stated value may be
required.





Income Taxes.In determining the carrying value of our net deferred tax assets, we must
assess the likelihood of sufficient future taxable income in certain tax
jurisdictions, based on estimates and assumptions, to realize the benefit of
these assets. If these estimates and assumptions change in the future, we may
record a reduction in the valuation allowance, resulting in an income tax
benefit in our Statements of Operations. Management evaluates the realizability
of the deferred tax assets and assesses the valuation allowance
quarterly.




14




We are
primarily subject to U.S. federal and state income tax. Tax years subsequent to
December 31, 2003 remain open to examination by U.S. federal and state tax
authorities. In addition, our policy is to recognize interest and penalties
related to income tax matters in income tax expense. As of September 30,
2009, we had no accruals for interest or penalties related to income tax
matters.





Amortization and
Impairment of Long Lived Assets.Long lived assets, such as property,
equipment and intangible assets are recorded at historical cost. We amortize our
intangible assets using the straight-line method over their estimated useful
lives, usually two to five years. We review intangible assets subject to
amortization periodically to determine if any adverse conditions exist or a
change in circumstances has occurred that would indicate impairment or a change
in the remaining useful life of the applicable asset. Conditions that would
indicate impairment and trigger a more frequent impairment assessment include,
but are not limited to a significant adverse change in the legal factors or
business climate that could affect the value of an asset, or an adverse action
or assessment by a regulator. If the carrying amount of an asset exceeds its
estimated fair value, an impairment charge is recognized for the amount by which
the carrying amount exceeds the estimated fair value of the asset. Assets to be
disposed of are reported at the lower of the carrying amount or fair value, less
the estimated costs to sell. In addition, depreciation of the asset ceases.
During the nine months ended September 30, 2009 and 2008, no impairment of
long-lived assets was recorded.





Revenue
Recognition. Our revenues are derived from the sale of surgical
visualization technology products to end users, distributors and original
equipment manufacturers. Revenue from the sale of products is recognized when
evidence of an arrangement exists, the product has been shipped, the selling
price is fixed or determinable,  collection is reasonably assured and
when both title and risk of loss transfer to the customer, provided that no
significant obligations remain. If installation is included as part of the
contract, revenue is not recognized until installation has occurred, or until
any remaining installation obligation is deemed to be perfunctory. Shipping and
handling costs are included in cost of sales.





For the
sale of products and services as part of a multiple-element arrangement, we
allocate revenue from multiple-element arrangements to the elements based on the
relative fair value of each element. For sales of extended warranties with a
separate contract price, Viking defers revenue equal to the separately stated
price. Revenue associated with undelivered elements is deferred and recorded
when delivery occurs.





Stock-Based
Compensation The measurement and recognition of compensation expense for
all share-based payment awards to employees and directors is based on estimated
fair values. The Company uses the Black-Scholes option valuation model to
estimate the fair value of its stock options at the date of grant. The
Black-Scholes option valuation model requires the input of subjective
assumptions to calculate the value of stock options. The Company uses historical
data among other information to estimate the expected price volatility, the
expected annual dividend, the expected option life and the expected forfeiture
rate.







15




ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





As a
Smaller Reporting Company as defined by Rule 12b-2 of the Exchange Act and in
Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting
obligations and therefore are not required to provide the information requested
by this Item.





ITEM
4T. CONTROLS AND PROCEDURES





Limitations
on the Effectiveness of Controls





We seek
to improve and strengthen our control processes to ensure that all of our
controls and procedures are adequate and effective. We believe that a control
system, no matter how well designed and operated, can only provide reasonable,
not absolute, assurance that the objectives of the controls system are met. In
reaching a reasonable level of assurance, management necessarily was required to
apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures. In addition, the design of any system of controls is
based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions. Over time, a control may
become inadequate because of changes in conditions, or the degree of compliance
with policies or procedures may deteriorate. No evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within a company will be detected.  As set forth below, our Chief
Executive Officer and our Executive Vice President and Chief Financial Officer
have concluded, based on their evaluation as of the end of the period covered by
this report, that our disclosure controls and procedures were sufficiently
effective to provide reasonable assurance that the objectives of our disclosure
control system were met.





Evaluation
of Effectiveness of Disclosure Controls and Procedures





Our
management evaluated, with the participation of our principal executive officer
and our principal financial officer, the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end
of the period covered by this quarterly report on Form 10-Q. Based on that
evaluation, our principal executive officer and our principal financial officer
concluded that our disclosure controls and procedures as of September 30, 2009
are effective to ensure that information we are required to disclose in reports
that we file or submit under the Exchange Act (i) are recorded, processed,
summarized and reported within the time periods specified in SEC rules and
forms, and (ii) are accumulated and communicated to our management, including
our principal executive officer and our principal financial officer, as
appropriate, to allow timely decisions regarding required reasonable assurance
that such information is accumulated and communicated to our management. Our
disclosure controls and procedures are designed to provide reasonable assurance
that such information is accumulated and communicated to our management. Our
disclosure controls and procedures include components of our internal control
over financial reporting. Management's assessment of the effectiveness of our
internal control over financial reporting is expressed at the level of
reasonable assurance that the control system, no matter how well designed and
operated, can provide only reasonable, but not absolute, assurance that the
control system's objectives will be met.





Changes
in Internal Control over Financial Reporting





There
were no changes in our internal controls over financial reporting identified in
connection with the evaluation required by paragraph (d) of Exchange Act Rules
13a-15 or 15d-15 that occurred during the last quarter that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.








16




PART II - OTHER
INFORMATION





ITEM
1. LEGAL PROCEEDINGS.





From time
to time, we may become involved in various lawsuits and legal proceedings that
arise in the ordinary course of business. We are currently not aware of, nor do
we have any knowledge of, any such legal proceedings or claims against us or our
officer and directors in their capacity as such that we believe will have,
individually or in the aggregate, a material adverse affect on our business,
financial condition or operating results.





ITEM
1A. RISK FACTORS.





Forward
Looking Statements





This
interim report on Form 10-Q contains and incorporates by reference certain
“forward-looking statements” with respect to results of our operations and
businesses. All statements, other than statements of historical facts, included
in this report on Form 10-Q, including those regarding market trends, our
financial position, business strategy, projected costs, and plans and objectives
of management for future operations, are forward-looking statements. In general,
such statements are identified by the use of forward- looking words or phrases
including, but not limited to, “intended,” “will,” “should,” “may,” “expects,”
“expected,” “anticipates,” and “anticipated” or the negative thereof or
variations thereon or similar terminology. These forward-looking statements are
based on our current expectations. Although we believe that the expectations
reflected in such forward-looking statements are reasonable, there can be no
assurance that such expectations will prove to be correct and our actual results
could differ materially. These forward-looking statements represent our judgment
as of the date of this Form 10-Q. We disclaim, however, any intent or obligation
to update our forward-looking statements, except as required by
law.





Risks
Related to our Business





Our
Independent Auditors have expressed substantial doubt about our ability to
continue as a going concern.





The
report dated April 15, 2009 from our independent registered public
accounting firm, Squar, Milner, Peterson, Miranda & Williamson, LLP, on our
financial statements for the year ended December 31, 2008 included a going
concern explanatory paragraph in which they stated that the financial statements
were prepared assuming that we would continue as a going concern and that there
was substantial doubt regarding the Company’s ability to continue as a going
concern.  Our ability to continue as a going concern is an issue raised as
a result of our significant operating losses and negative operating cash
flows.  During the nine months ended September 30, 2009, we incurred a
net loss of $882,669.  During the years ended December 31, 2008
and 2007, we incurred net losses of $5,752,057 and $923,290, respectively, and
we incurred negative cash flows from operating activities of $2,615,399 and
$6,792,845, respectively.  We will need to generate significant
revenue in order to achieve profitability and we may never become
profitable.  The going concern explanatory paragraph in the
independent auditor's report emphasizes the uncertainty related to our business
as well as the level of risk associated with an investment in our common
stock.





We
require additional financing and our inability to raise additional capital on
acceptable terms in the future may have a material adverse effect on our
business and financial condition.





We
believe that we may need to seek a business combination or additional financing
in order to fund our operations and carry out our business plan for the next
twelve months. The overall weakening of the economy and increased financial
instability of many borrowers has resulted in a general tightening of capital
availability.  Many lending and investing institutions that have
traditionally been sources of capital have experienced significant losses and a
lack of liquidity. These conditions may adversely impact our ability to raise
capital. There can be no assurance that a business combination or such financing
will be available on acceptable terms, or at all. We do not have any
arrangements with any bank or financial institution to provide additional
financing and there can be no assurance that any such arrangement, if required
or otherwise sought, would be available on terms deemed to be commercially
acceptable and in our best interests. Also, if we raise additional funds by
selling equity or equity-based securities, the percentage ownership of our
existing stockholders will be reduced and such equity securities may have
rights, preferences or privileges senior to those of the holders of our common
stock. Any inability to obtain additional cash as needed could have a material
adverse effect on our financial position, results of operations and ability to
continue operations.





As part
of managing our business, we frequently forecast our future cash flow and cash
position.  Such projections include assumptions regarding fulfillment
of existing orders, receipt and fulfillment of future orders and ultimately the
receipt of cash.  These forecasts also include assumptions regarding
the timing of payments related to existing and future liabilities and inventory
procurement.   If forecasted orders do not materialize or
existing orders were cancelled or reduced, this could have a material adverse
impact on our projected cash position and our ability to continue our
operations.





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The
recent deterioration of the economy and credit markets may adversely affect our
future results of operations.





Our
operations and performance depend to some degree on general economic conditions
and their impact on our customers’ finances and purchase
decisions.  As a result of recent economic events, potential customers
may elect to defer purchases of capital equipment items, such as the products we
manufacture and supply.  Additionally, the credit markets and the
financial services industry have been experiencing a period of upheaval
characterized by the bankruptcy, failure, collapse or sale of various financial
institutions and an unprecedented level of intervention from the United States
government. While the ultimate outcome of these events cannot be predicted, it
may have a material adverse effect on our customers’ ability to fund their
operations thus adversely impacting their ability to purchase our products or to
pay for our products on a timely basis, if at all.  These and other
economic factors could have a material adverse effect on demand for our
products, the collection of payments for our products and on our financial
condition and operating results.





We
will likely face significant competition which could adversely affect our
revenues, results of operations and financial condition.





The
market for medical products and services is highly competitive and new offerings
and technologies are becoming available regularly.  Many of our competitors
are substantially larger and more experienced than we are.  In
addition, they have longer operating histories and have materially greater
financial and other resources than we do.  If we cannot compete in the
marketplace, we may have difficulty selling our products and generating
revenues.  Additionally, competition may drive down the prices of our
products, which could adversely affect our cost of goods sold and our
profitability, if any.  We cannot guarantee that we will compete
successfully against our potential competitors.





We
depend upon our executive officers and key personnel.





Our
performance depends substantially on the performance of our executive officers
and other key personnel. Our future success will depend to a large extent
on retaining our employees and our ability to attract, train, retain and
motivate sufficient qualified employees to fill vacancies created by attrition
or expansion of our operations.  The loss of the services of any of
our executive officers or key personnel could have a material adverse effect on
our business, revenues, and results of operations or financial
condition.





Competition
for talented personnel is intense, and we may not be able to continue to
attract, train, retain or motivate other highly qualified technical and
managerial personnel in the future.  In addition, market conditions
may require us to pay higher compensation to qualified management and technical
personnel than we currently anticipate. Any inability to attract and retain
qualified management and technical personnel in the future could have a material
adverse effect on our business, prospects, financial condition, and/or results
of operations.





We
rely on a small number of customers and cannot be certain they will consistently
purchase our products in the future.





Sales to
individual customers exceeding 10% of revenues in the three and nine months
ended September 30, 2009 were to three customers who accounted for 49%, 20% and
17% and 37%, 24% and 15% of revenues, respectively. Sales to individual
customers exceeding 10% of revenues in the year ended December 31, 2008 were to
three customers who accounted for 30%, 19% and 11% of revenues,
respectively.  No other customer accounted for more than 10% of our
revenues during those periods.  In the future, a small number of
customers may continue to represent a significant portion of our total revenues
in any given period. We cannot be certain that such customers will consistently
purchase our products at any particular rate over any subsequent period.  A
loss of any of these customers could adversely affect our financial
performance.




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We
are subject to significant domestic and international regulations and may not be
able to obtain necessary regulatory clearances to sell our
products.





The
manufacture and sale of medical devices intended for commercial distribution are
subject to extensive governmental regulation.  Our failure to comply with
regulatory requirements would jeopardize our ability to market our
products.  Noncompliance with applicable requirements can result in failure
of the regulatory agency to grant pre-market clearance or approval for devices,
withdrawal or suspension of approval, total or partial suspension of production,
fines, injunctions, civil penalties, refunds, recall or seizure of products and
criminal prosecution. Medical devices are regulated in the United States
primarily by the FDA and, to a lesser extent, by state agencies.  Sales of
medical device products outside the United States are subject to foreign
regulatory requirements that vary from country to country.  Generally,
medical devices require pre-market clearance or pre-market approval prior to
commercial distribution.  A determination that information available on the
medical device is not sufficient to grant the needed clearance or approval will
delay market introduction of the product.  In addition, material changes or
modifications to, and changes in intended use of, medical devices also are
subject to FDA review and clearance or approval.  The FDA regulates the
research, testing, manufacture, safety, effectiveness, labeling, storage, record
keeping, promotion and distribution of medical devices in the United States and
the export of unapproved medical devices from the United States to other
countries.  The time required to obtain approvals required by foreign
countries may be longer or shorter than that required for FDA clearance, and
requirements for licensing may differ from FDA requirements.  The current
regulatory environment in Europe for medical devices differs significantly from
that in the United States.





We
must be able to adapt to rapidly changing technology trends and evolving
industry standards or we risk our products becoming obsolete.





The
medical device market in which we compete is characterized by intensive
development efforts and rapidly advancing technology.  Our future success
will depend, in large part, upon our ability to anticipate and keep pace with
advancing technology and competing innovations.  We may not be successful
in identifying, developing and marketing new products or enhancing our existing
products. We believe that a number of large companies, with significantly
greater financial, manufacturing, marketing, distribution and technical
resources and experience than ours, are focusing on the development of
visualization products for minimally invasive surgery.





Our
operating results may be adversely affected by the level of reimbursements for
surgical procedures using our products.





The level
of payments for the surgical procedures, in which our products are involved,
either by Medicare or private insurance companies may have a significant impact
on future operating results.  We could be adversely affected by changes in
payment policies of government or private health care payers, particularly to
the extent any such changes affect payment for the procedure in which our
products are intended to be used.  It is a continuing trend in United
States health care for such payments to be under continual scrutiny and downward
pressure.  We believe that reimbursement in the future will be subject to
increased restrictions, both in the United States and in foreign markets and
that the overall escalating cost of medical products and services has led to and
will continue to lead to increased pressures on the health care industry, both
foreign and domestic, to reduce the cost of products and services, including
products which we offer.





We expect
that our products typically will be used by hospitals and surgical centers,
which bill various third-party payers, such as governmental programs and private
insurance plans, for the health care services provided to their patients. 
Third-party payers carefully review and increasingly challenge the prices
charged for medical products and services or negotiate a flat rate fee in
advance.  Payment rates from private companies also vary depending on the
procedure performed, the third-party payer, the insurance plan and other
factors.  Medicare compensates hospitals at a predetermined fixed amount
for the costs associated with an in-patient hospitalization based on the
patient’s discharge diagnosis and compensates physicians at a pre-determined
fixed amount based on the procedure performed, regardless of the actual costs
incurred by the hospital or physician in furnishing the care and unrelated to
the specific devices or systems used in that procedure.  Medicare and other
third-party payers are increasingly scrutinizing whether to cover new products
and the level of payment for new procedures.  The flat fee reimbursement
trend is causing hospitals to control costs strictly in the context of a managed
care system in which health care providers contract to provide comprehensive
health care for a fixed cost per person.  We are unable to predict what
changes will be made in the reimbursement methods utilized by such third-party
payers.





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If we
obtain the necessary foreign regulatory registrations or approvals, market
acceptance of our products in international markets would be dependent, in part,
upon the acceptance by the prevailing health care financing system in each
country.  Health care financing systems in international markets vary
significantly by country and include both government sponsored health care
programs and private insurance.  We cannot assure you that these financing
systems will endorse the use of our products.





We
may be subject to product liability claims and have limited insurance
coverage.





By
engaging in the medical devices business, we will face an inherent business
risk of exposure to product liability claims in the event that the use of our
products results in personal injury or death.  Also, in the event that any
of our products proves to be defective, we may be required to recall or redesign
such products. We will need to maintain adequate product liability
insurance coverage.  If we are able to maintain insurance, of which there
can be no assurance, our coverage limits may not be adequate to protect us from
any liabilities we might incur in connection with the development, manufacture
and sale of our products.  Product liability insurance is expensive and in
the future may not be available to us on acceptable terms, if at all.  A
successful product liability claim or series of claims brought against us in
excess of our insurance coverage or a product recall would negatively impact our
business.





Risks
Related to our Stock





Investors
who purchase shares of our common stock should be aware of the possibility of a
total loss of their investment.





An
investment in our common stock involves a substantial degree of risk.
 Before making an investment decision, you should give careful
consideration to the risk factors described in this section in addition to the
other information contained in this annual report.  The risk factors
described herein, however, may not reflect all of the risks associated with our
business or an investment in our common stock.  You should invest in our
Company only if you can afford to lose your entire investment.





Our
current management, along with a select few investors, possess a majority of our
common stock and they may be able to control our Company
indefinitely.





A few of
our stockholders have significant control over our voting stock which may make
it difficult to complete some corporate transactions without their support and
may prevent a change in control.  As of November 1, 2009, our
directors and executive officers as a whole, may beneficially own approximately
18,612,916 shares or  43.6% of our outstanding common stock, and
assuming that the warrants and options (exercisable as of 60 days from November
1, 2009) were exercised, may beneficially own approximately 34,582,832 shares
or  58.93% of our outstanding common stock.  Certain of our
officers and directors disclaim beneficial ownership of certain shares included
in the description above. As of November 1, 2009, all of the warrants and
options included in the above calculation were at exercise prices above the
quoted market price of our common stock.





The
above-described significant stockholders may have considerable influence over
the outcome of all matters submitted to our stockholders for approval, including
the election of directors. In addition, this ownership could discourage the
acquisition of our common stock by potential investors and could have an
anti-takeover effect, possibly depressing the trading price of our common
stock.





“Penny
stock” rules may make buying or selling our securities difficult, which may
make our stock less liquid and make it harder for investors to buy and sell our
securities.





Our
common stock currently trades on the Over-the-Counter Bulletin
Board.  If the market price per share of our common stock is less than
$5.00, the shares may be “penny stocks” as defined in the Securities Exchange
Act of 1934, as amended, referred to as the Exchange Act.  As a
result, an investor may find it more difficult to dispose of or obtain accurate
quotations as to the price of these securities.  In addition, “penny
stock” rules adopted by the SEC under the Exchange Act subject the sale of these
securities to regulations which impose sales practice requirements on
broker-dealers.  For example, broker-dealers selling penny stocks
must, prior to effecting the transaction, provide their customers with a
document that discloses the risks of investing in penny stocks.





Furthermore,
if the person purchasing the securities is someone other than an accredited
investor or an established customer of the broker-dealer, the broker-dealer must
also approve the potential customer’s account by obtaining information
concerning the customer’s financial situation, investment experience and
investment objectives.  The broker-dealer must also make a
determination whether the customer has sufficient knowledge and experience in
financial matters to be reasonably expected to be capable of evaluating the risk
of transactions in penny stocks. Accordingly, the SEC’s rules may limit the
number of potential purchasers of shares of our common
stock.  Moreover, various state securities laws impose restrictions on
transferring “penny stocks,” and, as a result, investors in our securities may
have their ability to sell their securities impaired.





20





If
an active, liquid trading market for our common stock does not develop, you may
not be able to sell your shares quickly or at or above the price you paid for
it.





Although
our common stock currently trades on the Over-the-Counter Bulletin Board, an
active and liquid trading market for our common stock has not yet and may not
ever develop or be sustained.  You may not be able to sell your shares
quickly or at or above the price you paid for our stock if trading in our stock
is not active.





We
do not expect to pay dividends in the foreseeable future.





We do not
anticipate paying cash dividends on our common stock in the foreseeable future.
Any payment of cash dividends will depend on our financial condition, results of
operations, capital requirements and other factors and will be at the discretion
of our board of directors.





ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS.





We did
not sell any unregistered securities during the quarter ended September 30,
2009.





ITEM
3. DEFAULTS UPON SENIOR SECURITIES.





As
of  September 30, 2009, we are not in default with respect to any
indebtedness.





ITEM
4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.





We did
not submit any matters to a vote of security holders during the quarter ended
September 30, 2009.





ITEM 5. OTHER
INFORMATION.





None.







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ITEM
6. EXHIBITS





ExhibitNumber
            Exhibit3.1
            Certificate
      of Incorporation dated June 8, 2006 (included as Exhibit 3.1 to the
      Registrant's Annual Report on Form 10-KSB for the fiscal year ended
      December 31, 2007, and incorporated herein by
  reference).3.2
            Bylaws
      (included as Exhibit 3.3 to the Registrant's Annual Report on Form 10-KSB
      for the fiscal year ended December 31, 2007, and incorporated herein by
      reference).4.1
            Certificate
      of Preferences, Rights and Limitations of Series B Variable Dividend
      Convertible Preferred Stock (included as Exhibit 4.01 to the Form 8-K
      filed May 25, 2006, and incorporated herein by
  reference).10.1
            Stock
      Incentive Plan, dated March 31, 2004 (included as Exhibit 10.1 to the Form
      8-K filed April 1, 2004, and incorporated herein by
      reference).10.2
            2004
      Non-Employee Director Stock Ownership Plan dated December 29, 2005
      (included as Exhibit 10.2 to the Form 8-K filed April 1, 2004, and
      incorporated herein by reference).10.3
            Executive
      Change of Control Agreements between the Company and John Kennedy, and the
      Company and Robert Mathews dated August 6, 2008 (included as exhibits 99.2
      and 99.3 to the Form 8-K filed August 11, 2008, and incorporated herein by
      reference)10.4
            Independent
      Sales Agent Agreement between the Company and Platinum Medical Inc., dated
      November 21, 2006 (included as Exhibit 10.17 to the Registrant's Annual
      Report on Form 10-KSB for the fiscal year ended December 31, 2006, and
      incorporated herein by reference).10.5
            Lease
      between the Company and Robert F. Tambone as Trustee of MAT Realty Trust,
      dated September 23, 2004 (included as Exhibit 10.1 to the Form 8-K filed
      October 1, 2004, and incorporated herein by reference).10.6
            First
      Amendment to Lease between the Company and Robert F. Tambone as Trustee of
      MAT Realty Trust, dated February 5, 2007 (included as exhibit 10.18 to the
      Registrant's Annual Report on Form 10-KSB for the fiscal year ended
      December 31, 2006, and incorporated herein by
  reference).10.7
            Securities
      Purchase Agreement between the Company and various investors, dated
      February 23, 2007 (included as Exhibit 10.1 to the Form 8-K filed February
      27, 2007, and incorporated herein by reference).10.8
            Amendment
      to Securities Purchase Agreement between the Company and various
      investors, dated July 19, 2007 (included as Exhibit 10.11 to the Form 8-K
      filed August 2, 2007, and incorporated herein by
    reference).10.9
            Securities
      Purchase Agreement between the Company and various investors, dated July
      31, 2007 (included as Exhibit 10.1 to the Form 8-K filed August 2, 2007,
      and incorporated herein by reference).10.10
            Registration
      Rights Agreement between the Company and various investors, dated February
      23, 2007 (included as Exhibit 10.1 to the Form 8-K filed February 27,
      2007, and incorporated herein by reference).10.11
            Amendment
      No. 1 to Registration Rights Agreement between the Company and various
      investors, dated July 19, 2007 (included as Exhibit 10.7 to the Form 8-K
      filed August 2, 2007, and incorporated herein by
    reference).10.12
            Common
      Stock Purchase Warrant, dated February 23, 2007 (included as Exhibit 10.4
      to the Form 8-K filed February 27, 2007, and incorporated herein by
      reference).10.13
            8%
      Secured Convertible Debenture, dated July 31, 2007 (included as Exhibit
      10.2 to the Form 8-K filed August 2, 2007, and incorporated herein by
      reference).




22




10.14
            Consent,
      Waiver and Amendment Agreement, dated February 23, 2007 (included as
      Exhibit 10.6 to the Form 8-K filed February 27, 2007, and incorporated
      herein by reference).10.15
            Revised
      Consent, Waiver and Amendment Agreement, dated July 22, 2007 (included as
      Exhibit 10.10 to the Form 8-K filed August 2, 2007, and incorporate herein
      by reference).10.16
            Consent,
      Waiver and Amendment Agreement, dated July 19, 2007 (included as Exhibit
      10.6 to the Form 8-K filed August 2, 2007, and incorporated herein by
      reference).10.17
            Security
      Agreement between the Company and various investors, dated February 23,
      2007 (included as Exhibit 10.5 to the Form 8-K filed February 27, 2007,
      and incorporated herein by reference).10.18
            Amendment
      No. 1 to Security Agreement between the Company and various investors,
      dated July 19, 2007 (included as Exhibit 10.2 to the Form 8-K filed August
      2, 2007, and incorporated herein by reference).10.19
            Recapitalization
      Agreement between the Company and Securityholders, dated December 31, 2007
      (included as exhibit 99.1 to the Form 8-K filed January 7, 2008, and
      incorporated herein by reference).10.20
            Securities
      Purchase Agreement between the Company and various investors, dated
      January 4, 2008 (included as Exhibit 99.2 to the Form 8-K filed January 7,
      2008, and incorporated herein by reference).10.21
            Executive
      Employment Agreement between the Company and William C. Bopp, dated
      January 4, 2008 (included as Exhibit 99.3 to the Form 8-K filed January 7,
      2008, and incorporated herein by reference).10.22
            Amendment
      to Executive Employment Agreement between the Company and William C. Bopp,
      dated February 27, 2008 (included as Exhibit 99.2 to the Form 8-K filed
      February 29, 2008, and incorporated herein by
  reference).31.1
            Certification
      of Principal Executive Officer in accordance with 18 U.S.C. Section 1350,
      as adopted by Section 302 of the Sarbanes- Oxley Act of
    200231.2
            Certification
      of Principal Financial Officer in accordance with 18 U.S.C. Section 1350,
      as adopted by Section 302 of the Sarbanes-Oxley Act of
  200232.1
            Certification
      of Principal Executive Officer in accordance with 18 U.S.C. Section 1350,
      as adopted by Section 906 of the Sarbanes-Oxley Act of
  200232.2
            Certification
      of Principal Financial Officer in accordance with 18 U.S.C. Section 1350,
      as adopted by Section 906 of the Sarbanes-Oxley Act of
  2002




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SIGNATURE





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





Dated:
      November 6, 2009
            VIKING
      SYSTEMS, INC.By:
            /s/
      William C. BoppChief
      Executive Officer
              (Principal
      Executive Officer)By:
            /s/
      Robert MathewsExecutive
      Vice President and Chief Financial Officer
              (Principal
      Financial Officer and Principal Accounting Officer)











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