U.S.
      SECURITIES AND EXCHANGE COMMISSION


Washington,
      D.C. 20549




FORM
      10-QSB




ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES
      EXCHANGE ACT OF 1934





**For
      the quarterly period ended June 30, 2006**


OR


 ̈ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES
      EXCHANGE ACT OF 1934


**Commission
      file number 000-49636**




**VIKING
      SYSTEMS, INC.**


(Name
      of
      Small Business Issuer as specified in its charter)





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





4350,
      La Jolla Village Drive, Suite 900, San Diego, CA 92122


(Address
      of principal executive offices)





Registrant's
      telephone no., including area code: (858) 431-4010





4350
      La
      Jolla Village Drive, Suite 900, San Diego, CA 92122


Former
      name, former address, and former fiscal year, if changed since last
      report.





Securities
      registered pursuant to Section 12(b) of the Exchange Act: None





Securities
      registered pursuant to Section 12(g) of the Exchange Act: $.001 Par Value Common
      Stock





Check
      whether the Issuer (1) has filed all reports required to be filed by Section
      13
      or 15(d) of the Exchange Act 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. (1) Yes ý No  ̈ (2) Yes ý No  ̈





Indicate
      by check mark whether the registrant is an accelerated filer (as defined in
      rule
      12b-2 of the Exchange Act). Yes  ̈ No ý





Common
      Stock outstanding on August 17, 2006, 61,864,941 shares of $.001 par value
      Common Stock.





DOCUMENTS
      INCORPORATED BY REFERENCE: NONE











**FORM
      10-QSB**





**FINANCIAL
      STATEMENTS AND SCHEDULES**


**VIKING
      SYSTEMS, INC.**





**For
      the Quarter ended June 30, 2006**





**PART
      I - FINANCIAL INFORMATION**





Page
                ofForm
                10-QSBItem
                1.
            Financial
                Statements (unaudited):Balance
                Sheets at June 30, 2006 and December 31, 2005
            3Statements
                of Operations for the Three and Six MonthsEnded
                June 30, 2006 and 2005
            4Statements
                of Cash Flows for the Six MonthsEnded
                June 30, 2006 and 2005
            5Notes
                to Financial Statements
            7 -
                19Item
                2.
            Management's
                Discussion and Analysis of Financial Condition and Results of
                Operations
            20Item
                3.
            Controls
                and Procedures, Evaluation of Disclosure Controls and
                Procedures
            30




**PART
      II - OTHER INFORMATION**




PageItem
                1.
            Legal
                Proceedings
            30Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds.
            30Item
                3.
            Defaults
                Upon Senior Securities
            30Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            30Item
                5.
            Other
                Information
            31Item
                6.
            Exhibits
            32





2


**PART
      I - FINANCIAL INFORMATION**


**ITEM
      1: FINANCIAL STATEMENTS**


**VIKING
      SYSTEMS, INC.**


**Balance
      Sheets - Unaudited**




June
                30, 2006
            
            December
                31, 2005**Assets**Current
                assets:Cash
                and cash equivalents
            
            $
            3,922,357
            
            $
            434,503Accounts
                receivable, net
            
            
            276,868
            
            
            248,258Inventories
            
            
            915,724
            
            
            567,176Prepaid
                expenses
            
            
            32,346
            
            
            48,148Other
                current assets
            
            
            79,293
            
            
            34,789Total
                current assets
            
            
            5,226,588
            
            
            1,332,874Property
                and equipment, net
            
            
            300,110
            
            
            377,632Total
                Assets
            
            $
            5,526,698
            
            $
            1,710,506**Liabilities
                and Stockholders' Deficit**Current
                liabilities:Accounts
                payable
            
            $
            693,081
            
            $
            515,781Accrued
                payroll and related expenses
            
            
            242,982
            
            
            230,773Accrued
                royalties
            
            
            98,702
            
            
            84,658Other
                accrued expenses
            
            
            197,681
            
            
            112,916Deferred
                revenue
            
            
            15,188
            
            
            -Short-term
                bank borrowings
            
            
            -
            
            
            211,200Related
                party convertible notes payable
            
            
            -
            
            
            766,918Convertible
                notes payable net of debt discount
            
            
            -
            
            
            1,502,158Derivative
                liability
            
            
            7,953,902
            
            
            -Total
                current liabilities
            
            
            9,201,536
            
            
            3,424,404Commitments
                and contingenciesSeries
                B preferred stock, $0.001 par value; 8,000 shares authorized,
                issued and outstanding at June 30, 2006. No shares authorized,
                issued and outstanding at December 31, 2005 (aggregate liquidation
                preference of $8,068,384 and $0 at June 30, 2006 and December
                31, 2005), respectively
            
            
            8,068,384
            
            
            -





Stockholders'
                deficitPreferred
                  stock, $.001 par value, 25,000,000 shares authorized, 8,000 and
                  0 shares
                  of Series B preferred stock issued and outstanding at June 30,
                  2006 and
                  December 31, 2005, respectively.
            
            
            -
            
            
            -Common
                  stock, $.001 par value, 200,000,000 shares authorized; 61,864,941and
                  34,526,550 shares issued and outstanding at June 30, 2006 and and
                  December
                  31, 2005, respectively.
            
            
            61,865
            
            
            34,528Additional
                paid-in capital
            
            
            6,783,094
            
            
            8,095,714Accumulated
                deficit
            
            
            (18,588,181
            )
            
            (9,844,140
            )Total
                stockholders' deficit
            
            
            (11,743,222
            )
            
            (1,713,898
            )Total
                liabilities and stockholders' deficit
            
            $
            5,526,698
            
            $
            1,710,506




See
      accompanying notes to financial statements


3





**VIKING
      SYSTEMS, INC.**


**Statements
      of Operations - Unaudited**




**Three
                Months Ended**
            
            **Six
                Months Ended****June
                30,**
            
            **June
                30,****2006**
            
            **2005**
            
            **2006**
            
            **2005**Sales,
                net
            
            $
            883,180
            
            $
            1,082,413
            
            $
            2,138,024
            
            $
            1,958,816Cost
                of sales
            
            
            742,823
            
            
            806,425
            
            
            1,632,700
            
            
            1,425,650Gross
                profit
            
            
            140,357
            
            
            275,988
            
            
            505,324
            
            
            533,166Operating
                expenses:General
                and administrative
            
            
            684,434
            
            
            337,476
            
            
            1,213,624
            
            
            829,242Selling
                and marketing
            
            
            1,135,241
            
            
            695,225
            
            
            2,009,609
            
            
            1,169,043Research
                and development
            
            
            314,036
            
            
            235,904
            
            
            624,260
            
            
            427,280Total
                operating expenses
            
            
            2,133,711
            
            
            1,268,605
            
            
            3,847,493
            
            
            2,425,565Operating
                loss
            
            
            (1,993,354
            )
            
            (992,617
            )
            
            (3,342,169
            )
            
            (1,892,399
            )Other
                income (expense):Interest
                income
            
            
            21,787
            
            
            -
            
            
            21,787
            
            
            -Interest
                expense
            
            
            (160,584
            )
            
            (70,101
            )
            
            (305,995
            )
            
            (93,899
            )Gain
                on extinguishment of debt
            
            
            4,975,824
            
            
            -
            
            
            4,975,824
            
            
            -Amortization
                of debt discount
            
            
            (5,500,000
            )
            
            (687,501
            )
            
            (8,480,878
            )
            
            (754,033
            )Loss
                on derivative liability
            
            
            (1,612,610
            )
            
            -
            
            
            (1,612,610
            )
            
            -Net
                loss
            
            
            (4,268,937
            )
            
            (1,750,219
            )
            $
            (8,744,041
            )
            
            (2,740,331
            )Deemed
                dividend on Series B Preferred StockAccretion
                of Series B Preferred Stock to redemption value including dividend
                accrued
            
            
            (8,068,384
            )
            
            
            
            
            (8,068,384
            )Net
                loss applicable to common stockholders
            
            $
            (12,337,321
            )
            $
            (1,750,219
            )
            $
            (16,812,425
            )
            $
            (2,740,331
            )Net
                  loss applicable to common stockholders per share - basic and
                  diluted
            
            $
            (0.27
            )
            $
            (0.06
            )
            $
            (0.41
            )
            $
            (0.09
            )Weighted
                average shares - basic and diluted
            
            
            45,173,339
            
            
            31,911,000
            
            
            40,605,421
            
            
            31,331,000




See
      accompanying notes to financial statement **s**





4


**VIKING
      SYSTEMS, INC.**


**Unaudited
      Statements of Cash Flows for the Six Months ended June 30**





**2006**
            
            **2005****Cash
                flows from operating activities:**Net
                loss
            
            $
            (8,744,041
            )
            $
            (2,740,331
            )Adjustment
                  to reconcile net loss to net cashused in operating
                  activities:Depreciation
                and amortization
            
            
            165,572
            
            
            108,255Common
                stock issued for services
            
            
            44,041
            
            
            7,500Stock
                based compensation expense
            
            
            242,364
            
            
            -Amortization
                of debt discount
            
            
            8,480,878
            
            
            754,033Gain
                on extinguishment of debt
            
            
            (4,975,824
            )
            
            -Loss
                on derivative liability
            
            
            1,612,610
            
            
            -Change
                in operating assets and liabilities:Accounts
                receivable, net
            
            
            (28,610
            )
            
            (73,574
            )Inventories,
                net
            
            
            (324,177
            )
            
            144,383Prepaid
                expenses
            
            
            15,802
            
            
            72,414Other
                current assets
            
            
            (44,504
            )
            
            -Accounts
                payable
            
            
            177,300
            
            
            (954,077
            )Accrued
                salaries and related expenses
            
            
            12,209
            
            
            -Accrued
                royalties
            
            
            14,044
            
            
            -Other
                accrued expenses
            
            
            84,765
            
            
            118,491Deferred
                revenue
            
            
            15,188
            
            
            (159,150
            )Net
                cash used in operating activities
            
            
            (3,252,383
            )
            
            (2,722,056
            )**Cash
                flows from investing activities:**Purchase
                of property and equipment
            
            
            (112,421
            )
            
            (273,978
            )Net
                cash used in investing activities
            
            
            (112,421
            )
            
            (273,978
            )





**Cash
                flows from financing activities:**Net
                change in short-term bank borrowings
            
            
            (211,200
            )
            
            106,785Proceeds
                from issuance of preferred stock, net
            
            
            7,250,000
            
            
            -Payment
                of preferred stock offering costs
            
            
            (436,142
            )
            
            -Proceeds
                from related party notes
            
            
            200,000
            
            
            100,000Repayment
                of related party notes
            
            
            (200,000
            )
            
            -Proceeds
                from convertible debt
            
            
            250,000
            
            
            2,750,000Net
                cash provided by financing activities
            
            
            6,852,658
            
            
            2,956,785Net
                increase (decrease) in cash and cash equivalents
            
            
            3,487,854
            
            
            (39,249
            )Cash
                and cash equivalents at beginning of period
            
            
            434,503
            
            
            139,393Cash
                and cash equivalents at end of period
            
            $
            3,922,357
            
            $
            100,144**Supplemental
                disclosure of cash flow information:**Cash
                paid during the period for:Interest
            
            $
            150,428
            
            $
            23,797Income
                taxes
            
            $
            -
            
            $
            -




See
      accompanying notes to financial statements


5





**Non-Cash
      Investing and Financing Activity**


*Six
      months ended June 30, 2006:*





During
      the six months ended June 30, 2006, the Company:





**·**
            Converted
                $4,300,000 of convertible notes payable into 23,888,891 shares of
                common
                stock**·**
            Converted
                $450,000 of convertible notes payable held by Donald Tucker, a significant
                shareholder, and the Company’s President and Chief Executive Officer into
                2,500,000 shares of common stock**·**
            Converted
                $750,000 of convertible notes payable into 750 shares of Series B
                Preferred stock**·**
            Issued
                837,000 shares of common stock pursuant to a cashless exercise of
                1,000,000 non qualified stock options issued in December
                2003.





*Six
      months ended June 30, 2005:*





During
      the six months ended June 30, 2005 the Company:





**·**
            Allocated
                $825,000 of the proceeds from a convertible note payable to the value
                of
                the warrants issued, recording it as a debt discount.**·**
            Converted
                a $500,000 note payable held by Donald Tucker, a significant shareholder,
                and $16,659 of accrued interest into 1,291,650 shares of common
                stock.





See
      accompanying notes to financial statements





6








**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**1.** **INTERIM
      FINANCIAL STATEMENTS**





The
      balance sheet of Viking Systems, Inc. (“Viking” or the “Company”) as of June 30,
      2006 and the statements of operations and cash flows for the six months ended
      June 30, 2006 and 2005 are unaudited. However, management, in its opinion,
      has
      made all adjustments (consisting only of normal recurring accruals) necessary
      to
      present fairly the financial position, results of operations and cash flows
      for
      the periods presented. The balance sheet as of December 31 2005 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 years ended December 31, 2005, included in Viking Systems, Inc’s
      Form 10-KSB filed on April 17, 2006 with the Securities and Exchange Commission.
      The results of operations and cash flows for the three and six months ended
      June
      30, 2006, are not necessarily indicative of results to be expected for the
      fiscal year ending December 31, 2006.





**2.
      LIQUIDITY AND** **GOING
      CONCERN** ****





The
      accompanying financial statements have been prepared on a going concern basis
      which contemplates the realization of assets and the satisfaction of liabilities
      in the normal course of business. Historically, the Company has incurred
      significant losses, and has not demonstrated the ability to generate sufficient
      cash flows from operations to satisfy its liabilities and sustain operations.
      Our independent registered public accounting firm included a going concern
      uncertainty explanatory paragraph in their report dated March 20, 2006, which
      is
      included in our Form 10-K for the year ended December 31, 2005.





The
      Company’s continuation as a going concern is dependent on its ability to
      generate sufficient income and cash flow to meet its obligations on a timely
      basis and/or obtain additional financing as may be required. During the
      six-months ended June 30, 2006 the Company generated net proceeds of
      approximately $6.9 million from financing activities. In addition, the Company
      continues to examine all aspects of its business for areas of improvement and
      continues to focus on increasing revenues and gross margins, reducing its fixed
      cost base and improving the Company’s working capital position. However, if
      anticipated improvements in operating results and cash flows from operations
      do
      not materialize, the Company will need to further reduce expenses. The Company
      also may require additional equity or debt financing to meet its working capital
      requirements. The sale of additional equity securities or debt financing could
      result in additional dilution to the Company’s current stockholders. There can
      be no assurance that additional financing, if required, will be available on
      terms satisfactory to the Company.





The
      financial statements included herein do not include any adjustments relating
      to
      the recoverability and classification of recorded assets or the amount or
      classification of liabilities or any other adjustments that might be necessary
      should the Company be unable to continue as a going
      concern.





7








**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**3.
        **INVENTORY****




Details
      of our inventory account balances as of June 30, 2006 and December 31, 2005
      are
      as follows:





**June
                  30, 2006**
            
            **December
                  31, 2005**Inventories:Parts
                and supplies
            
            $
            296,912
            
            $
            292,277Work-in-progress
            
            
            294,422
            
            
            150,016Finished
                goods
            
            
            324,390
            
            
            124,883$
            915,724
            
            $
            567,176





**4.
        **STOCK-BASED
        COMPENSATION****




On
      January 1, 2006 the Company adopted Statement of Financial Accounting Standards
      (“SFAS”) No.123 (Revised 2004), “Share Based Payment,” (“SFAS 123R”), using the
      modified prospective method. In accordance with SFAS 123R, 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.







Under
      the
      modified prospective approach, SFAS 123R applies to new awards and to awards
      that were outstanding on January 1, 2006 that are subsequently modified,
      repurchased or cancelled. Under the modified prospective approach, compensation
      cost recognized for the first quarter of fiscal 2006 includes compensation
      cost
      for all share-based payments granted prior to, but not yet vested on, January
      1,
      2006, based on the grant-date fair value estimated in accordance with the pro
      forma provisions of SFAS 123, and compensation cost for all share-based payments
      granted subsequent to January 1, 2006, based on the grant-date fair value
      estimated in accordance with the provisions of SFAS 123R. Prior periods were
      not
      restated to reflect the impact of adopting the new standard. During the three
      and six month periods ended June 30, 2006, the Company recorded $85,752 and
      $242,364 respectively, in non-cash stock-based compensation expense related
      to
      the implementation of SFAS 123R. As of June 30, 2006, there was approximately
      $968,020 of total unrecognized compensation costs related to unvested options,
      which is expected to be recognized over a weighted average period of
      approximately 2.67 years.





8





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**5.
        **STOCK-BASED
        COMPENSATION****(continued)****




The
      fair
      value of stock options at date of grant was estimated using the Black-Scholes
      model with the following assumptions: expected volatility of 79.7%, expected
      term of 10 years, risk-free interest rate of 5.23%, and expected dividend yield
      of 0%. Expected volatility is based on the historical volatilities of the
      Company’s common stock. The expected life of employee stock options is
      determined using historical data of employee exercises and represents the period
      of time that stock options are expected to be outstanding. The risk free
      interest rate is based on U.S. Treasury constant maturing for the expected
      life
      of the stock option.





The
      following table summarizes the stock option transactions during the six months
      ended June 30, 2006:





**Number
                of Shares**
            
            **Weighted
                - Average Exercise Price**
            
            **Weighted
                - Average Contractual Life**Options
                outstanding December 31, 2005
            
            
            5,706,000
            
            $
            0.38
            
            
            4.95Granted
            
            
            1,040,000
            
            
            0.37
            
            
            9.84Exercised
            
            
            (1,000,000
            )
            
            0.02
            
            
            -Cancelled
            
            
            (40,000
            )
            
            0.53
            
            
            -Options
                outstanding March 31, 2006
            
            
            5,706,000
            
            
            0.45
            
            
            6.27Granted
            
            
            1,590,000
            
            
            0.43
            
            
            9.88Exercised
            
            
            -Cancelled
            
            
            (520,000
            )
            
            0.45
            
            
            5.84Options
                outstanding June 30, 2006
            
            
            6,776,000
            
            
            0.48
            
            
            6.94Options
                Exercisable at March 31, 2006
            
            
            2,140,667
            
            
            0.39
            
            
            6.11Options
                Exercisable at June 30, 2006
            
            
            2,260,667
            
            
            0.39
            
            
            6.05





Prior
      to
      January 1, 2006, the Company accounted for stock-based compensation using the
      intrinsic value method prescribed in Accounting Principles Board Opinion No.
      25,
“Accounting for Stock Issued to Employees,” and related interpretations. Had
      compensation cost for the plan been determined based on the fair value of the
      options at the grant dates consistent with the method of SFAS No. 148,
“Accounting for Stock-Based Compensation - Transition and Disclosure - an
      Amendment of SFAS No. 123,” the Company’s net earnings and earnings per share
      would have been:





9





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**








**4.** **STOCK-BASED
      COMPENSATION** **(continued)**





For
                the three
            
            For
                the sixmonths
            
            monthsended
                June 30,
            
            ended
                June 30,2005
            
            2005Net
                loss as reported
            
            $
            (1,750,219
            )
            $
            (2,740,331
            )Deduct:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards, net of related tax
                effects
            
            
            (16,749
            )
            
            (33,499
            )Pro
                forma net loss
            
            $
            (1,766,968
            )
            $
            (2,733,830
            )Basic
                and diluted loss per share - as reported
            
            $
            (0.06
            )
            $
            (0.09
            )Basic
                and diluted loss per share - proforma
            
            $
            (0.06
            )
            $
            (0.09
            )





The
      pro
      forma compensation costs presented above were determined using the weighted
      average fair values of options granted under the Company’s stock option plans.
      The fair value of the grants was estimated using the Black-Scholes option
      pricing model with the following weighted-average assumptions.





Expected
                life
            
            
            10
                yearsRisk-free
                interest rate
            
            
            4.86
                - 5.23
            %Dividend
                yield
            
            
            -Volatility
            
            
            87-89
            %





**5.** **RECENT
      ACCOUNTING PRONOUNCEMENTS**





In
      February 2006, the Financial Accounting Standards Board (“FASB”) released
      Statement No. 155, Accounting for Certain Hybrid Financial Instruments,
      ("SFAS No. 155"). SFAS No. 155 is an amendment of Statement
      No. 133, Accounting for Derivative Instruments and Hedging Activities, and
      Statement No. 140, Accounting for Transfers and Servicing of Financial
      Assets and Extinguishments of Liabilities. SFAS No. 155 establishes, among
      other items, the accounting for certain derivative instruments embedded within
      other types of financial instruments; and, eliminates a restriction on the
      passive derivative instruments that a qualifying special-purpose entity may
      hold. Effective for the Company beginning January 1, 2007, SFAS
      No. 155 is not expected to have any impact on the Company's financial
      position, results of operations or cash flows.





10





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**5.** **RECENT
      ACCOUNTING PRONOUNCEMENTS (** **continued)**





In
      March 2006, the FASB released Statement No. 156, Accounting for
      Servicing of Financial Assets, an amendment of FASB Statement No. 140,
      ("SFAS No. 156"). SFAS No. 156 amends SFAS No. 140 to require
      that all separately recognized servicing assets and liabilities in


accordance
      with SFAS No. 140 be initially measured at fair value, if practicable.
      Furthermore, this standard permits, but does not require, fair value measurement
      for separately recognized servicing assets and liabilities in subsequent
      reporting periods. SFAS No. 156 is also effective for the Company beginning
      January 1, 2007; however, the standard is not expected to have an impact on
      the Company's financial position, results of operation or cash flows.





In
      the
      first quarter of 2006, the Company adopted Statement No. 154, Accounting
      for Changes and Error Corrections—a replacement of APB Opinion No. 20 and
      FASB Statement No. 3 , ("SFAS No. 154") which changed the requirements
      for the accounting for and reporting of a voluntary change in accounting
      principle. The Company also adopted Statement No. 151, Inventory Costs—an
      amendment of ARB No. 43, Chapter 4 ("SFAS No. 151") which, among other
      changes, requires certain abnormal expenditures to be recognized as expenses
      in
      the current period versus capitalized as a component of inventory. The adoption
      of SFAS No. 154 did not impact the results presented and the impact on any
      future periods will depend on the nature and significance of any future
      accounting changes subject to the provisions of the statement. The adoption
      of
      SFAS No. 151 did not have any impact on the Company's financial position,
      results of operations or cash flows.





In
      June
      2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in
      Income Taxes - an interpretation of FASB Statement No. 109," ("FIN 48"). FIN
      48
      clarifies the accounting for uncertainty in tax positions and requires that
      a
      Company recognize in its financial statements the impact of a tax position,
      if
      that position is more likely than not of being sustained on audit, based on
      the
      technical merits of the position. The provisions of FIN 48 are effective for
      fiscal years beginning after December 15, 2006. The adoption of FIN 48 is not
      expected to have any impact on the Company's financial position, results of
      operations or cash flows.





**6.
      SERIES B** **CONVERTIBLE
      PREFERRED STOCK**





In
      May 2006, our Board of Directors adopted a resolution designating a Series
      B
      preferred stock consisting of 8,000 shares. All 8,000 shares of Series B
      Preferred Stock (“Preferred Stock”) authorized have been issued. Each
      share of Series B Preferred, par value $0.001 per share, with a
“Stated Value” of $1,000 per share, is convertible ,
      subject
      to adjustments, into approximately 5,555 shares of common stock and warrants
      to
      purchase an additional 2,778 shares of common stock at an initial price of
      $0.35
      per share.





In
      May,
      2006 the Company issued the Series B Preferred for gross proceeds of
      $8,000,000, and incurred approximately $436,143 in issuance costs, which are
      recorded as a discount to the carrying value of the Series B Preferred.
      Proceeds from the sale of Series B Preferred consisted of $7,250,000 in cash
      and
      the conversion of $750,000 of convertible notes.





11





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**6.
      SERIES B** **CONVERTIBLE
      PREFERRED STOCK** ( continued)





The
      Company expects to use the proceeds for general corporate purposes. The Company
      has recorded the redeemable convertible preferred stock as mezzanine equity
      on
      the accompanying balance sheet in accordance with the provisions of Emerging
      Issues Task Force (“EITF”) Topic D-98: “Classification and Measurement of
      Redeemable Securities” (“EITF Topic D-98”).





In
      accordance with EITF Issue No. 98-5 “Accounting for Convertible Securities with
      Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,”
and EITF Issue No. 00-27 “Application of Issue No. 98-5 to Certain Convertible
      Instruments,” proceeds from the issuance of the Preferred Stock were allocated
      to the fair value of warrants issued in connection with the issuance of the
      Preferred Stock, and to the intrinsic value of the beneficial conversion feature
      (“BCF”) , based on their respective relative fair values. Based on this
      allocation, the fair value of the warrants totaling $3,590,050 was recorded
      as a
      discount to preferred stock and an increase to warrant derivative liability,
      and
      the intrinsic value of the BCF was recorded as a discount to preferred stock
      and
      as additional paid in capital.





The
      following table summarizes the valuation of the Series B Preferred for the
      three and six month periods ended June 30, 2006.





Convertible
                preferred stock
            
            $
            8,000,000Less:Issuance
                costs
            
            
            436,142Fair
                value of warrants
            
            
            3,590,050Beneficial
                conversion feature
            
            
            3,973,808Subtotal
            
            $
            0Plus:Accrued
                dividends
            
            
            68,384Accretion
                of discount to redemption value
            
            
            8,000,000Convertible
                preferred stock
            
            $
            8,068,384





The
      Company recorded the accretion of the Series B Preferred discount to its
      redemption value at issuance, since the preferred shares were immediately
      convertible. Total accretion of the discount to the Series B Preferred
      redemption value was recorded as a change to additional paid in capital and
      to
      the net loss attributable to common stockholders, amounting to $8,000,000 as
      of
      June 30, 2006. In addition, the Company accreted the dividend on the preferred
      stock as a charge to additional paid in capital.





Following
      is a summary of the Series B Preferred stock rights, preferences and
      privileges:




12


**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**6.
      SERIES B** **CONVERTIBLE
      PREFERRED STOCK** ( continued)





Dividends .
      Holders
      of the Series B Preferred Stock (each a “Holder”) are entitled to receive
      cumulative dividends at the rate per share of (i) up to and including May 22,
      2009, 8% per annum, (ii) from May 22, 2009 through and including May 22, 2010,
      11% per annum, and (iii) after May 22, 2011, 14% per annum. Dividends shall
      be
      paid in cash or shares of Viking common stock, or a combination thereof,
      pursuant to the terms and conditions of the transaction documents. Dividends are
      payable on the first day following the end of each fiscal quarter of the
      Company. Dividends do not compound; provided, that if the Company fails to
      pay
      such dividends as required, then accrued but unpaid dividends shall bear an
      interest rate of eighteen percent (18%) per annum compounding daily. Under
      certain circumstances, if dividend payments have not been made, at the Holder’s
      option, unpaid dividends may be accreted to, and increase, the outstanding
      Stated Value.




During
      the three and six month periods ended June 30, 2006, the Company recorded
      preferred stock dividends of approximately $68,384 as an increase to the net
      loss available to common stockholders in the accompanying consolidated statement
      of operations. All of this amount remained unpaid as of June 30,
      2006.





Voting
      Rights .
      The
      holders of the Preferred Stock have no voting rights unless required under
      applicable state corporate law.





Liquidation. Upon any
      liquidation, dissolution, or winding-up of Viking, whether voluntary or
      involuntary (a “Liquidation”), the holders of Series B Preferred Stock shall be
      entitled to receive out of the assets, whether capital or surplus, of Viking
      an
      amount equal to the stated value of the Series B Preferred Stock ($1,000 per
      share), plus any accrued and unpaid dividends thereon and any other fees or
      liquidated damages owing thereon, for each share of Series B Preferred Stock
      before any distribution or payment shall be made to the holders of any junior
      securities, and if the assets of Viking shall be insufficient to pay in full
      such amounts, then the entire assets to be distributed to the holders of the
      Series B Preferred Stock shall be ratably distributed among the holders in
      accordance with the respective amounts that would be payable on such shares
      if
      all amounts payable thereon were paid in full.





Conversion . The
      stated value of the shares of Preferred Stock are initially convertible into
      shares of Viking’s common stock at a price of $.18 per share; however, the
      conversion price is subject to adjustment based upon certain conditions. 
If all shares of Preferred Stock are converted into common stock at the initial
      conversion price, of which there can be no assurance, approximately 44,444,444
      shares of common stock will be issued in such conversion. “Certain Price and
      Share Adjustments,” below, describes circumstances under which the Conversion
      Price may be modified.





13





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**6.
      SERIES B** **CONVERTIBLE
      PREFERRED STOCK** ( continued)





Certain
      Price and Share Adjustments .





a)
      Stock Dividends and Stock Splits .
      If
      Viking (A) pays a stock dividend or otherwise makes a distribution or
      distributions payable in shares of common stock on shares of common stock or
      any
      other common stock equivalents; (B) subdivides outstanding shares of common
      stock into a larger number of shares; (C) combines (including by way of a
      reverse stock split) outstanding shares of common stock into a smaller number
      of
      shares; or (D) issues, in the event of a reclassification of shares of the
      common stock, any shares of capital stock of Viking, then the conversion price
      shall be adjusted accordingly.





b)  Subsequent
      Equity Sales .
      If
      Viking sells or grants any option to purchase or sells or grants any right
      to
      reprice its securities, or otherwise disposes of or issues any common stock
      or
      common stock equivalents entitling any person to acquire shares of common stock
      at an effective price per share that is lower than the then conversion price
      of
      the Series B Preferred Stock (such lower price, the “ Base
      Conversion Price ”
and
      such issuances collectively, a “ Dilutive
      Issuance ”),
      then
      the conversion price shall be reduced, by multiplying the conversion price
      by a
      fraction, the numerator of which is the number of shares of common stock issued
      and outstanding immediately prior to the Dilutive Issuance plus the number
      of
      shares of common stock that the actual cash offering price for such Dilutive
      Issuance would purchase at the then Exercise Price, and the denominator of
      which
      shall be the sum of the number of shares of common stock issued and outstanding
      immediately prior to the Dilutive Issuance plus the number of shares of common
      stock so issued or issuable in connection with the Dilutive Issuance, but in
      no
      event shall such adjustment reduce the Conversion Price to less than $0.05.




c)  Subsequent
      Rights Offerings .
      If
      Viking shall issue rights, options, or warrants to all holders of common stock
      entitling them to subscribe for or purchase shares of common stock at a price
      per share that is lower than the effective value weighted average price
      (“VWAP”), then the conversion price shall be multiplied by a fraction of which
      the denominator shall be the number of shares of the common stock outstanding
      on
      the date of issuance of such rights or warrants plus the number of additional
      shares of common stock offered for subscription or purchase, and of which the
      numerator shall be the number of shares of the common stock outstanding on
      the
      date of issuance of such rights or warrants plus the number of shares which
      the
      aggregate offering price of the total number of shares so offered (assuming
      delivery to Viking in full of all consideration payable upon exercise of such
      rights, options or warrants) would purchase at such VWAP. Such adjustment shall
      be made whenever such rights or warrants are issued, and shall become effective
      immediately after the record date for the determination of stockholders entitled
      to receive such rights, options or warrants.





14





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**6. SERIES B CONVERTIBLE
      PREFERRED STOCK**(continued)





Redemptions . Subject
      to certain conditions, the Company, at any time after the four year


anniversary
      of the date that the Company’s registration statement covering the shares of
      common stock issuable upon conversion of the Preferred Stock is declared
      effective by the Securities and Exchange Commission, may redeem shares of
      Preferred Stock at the Stated Value plus any accrued and unpaid dividends and
      any other amounts due in respect of the Preferred Stock.





Pursuant
      to the terms and conditions of the transaction documents, upon the occurrence
      of certain
      events (each a “Triggering Event”), each Holder has the right to require the
      Company to redeem
      Preferred Stock for cash or for shares of Viking common stock. Depending upon
      the nature of the Triggering Event the Holder would:





(1)
      receive in cash for each share of Preferred Stock, the sum of (i) the greater
      of
      (A) 130% of the Stated Value or (B) the product of (a) the VWAP on the Trading
      Day immediately preceding the date of the Triggering Event and (b) the Stated
      Value divided by the then Conversion Price, (ii) all accrued but unpaid
      dividends thereon and (iii) all liquidated damages and other costs, expenses
      or
      amounts due in respect of the Preferred Stock, or





(2)
      either (a) redeem all of the Preferred Stock then held by such Holder for a
      redemption price, in shares of Common Stock, equal to a number of shares of
      Common Stock equal to the sum of (i) the greater of (A) 130% of the Stated
      Value
      or (B) the product of (a) the VWAP on the Trading Day immediately preceding
      the
      date of the Triggering Event and (b) the Stated Value divided by the then
      Conversion Price, (ii) all accrued but unpaid dividends thereon and (iii) all
      liquidated damages and other costs, expenses or amounts due in respect of the
      Preferred Stock divided by 75% of the average of the 10 VWAPs immediately prior
      to the date of election to redeem Preferred Stock for common stock, or (b)
      increase the dividend rate on all of the outstanding Preferred Stock held by
      such Holder to 18% per annum thereafter.





Registration
      Rights The
      Company and the Holders entered into a “Registration Rights Agreement” on
      May 22, 2006. Among other things, the Company was obligated to file a
      registration statement on Form SB-2 and cause such registration statement
      to become effective within 90 days (or 120 days in the event of a “full review”
by the Securities and Exchange Commission). The agreement provides for
      liquidated damages by the Company to the Holders if the Company is unable to
      complete the registration, or subsequent registrations, or maintain such
      effectiveness.





15





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**7.
        **WARRANTS AND DERIVATIVE
        LIABILITY********




The
      following table summarizes warrants outstanding as of June 30,
      2006:





**Weighted****Weighted**
            
            **Average****Range
                of**
            
            **Average**
            
            **Remaining****Exercise**
            
            **Exercise**
            
            **Contractual****Shares**
            
            **Prices**
            
            **Prices**
            
            **Life**Warrants
                outstanding December 31, 2005
            
            
            7,187,500
            
            $
            0.40
            
            $
            0.40
            
            $
            3.10Granted
            
            
            25,694,451
            
            
            0.35
                - 0.75
            
            
            0.38
            
            
            4.83Exercised
            
            
            
            
            
            -
            
            
            -Cancelled
            
            
            (1,187,500
            )
            
            0.40
            
            
            0.40
            
            
            2.92Warrants
                outstanding June 30, 2006
            
            
            31,694,451
            
            $
            0.35
                - 0.75
            
            $
            0.37
            
            $
            4.41




During
        the six months ended June 30, 2006, the Company issued a total of 25,694,451
        warrants to purchase shares of its common stock at a weighted average exercise
        price of $0.38. Included in this total are the following:
 
 ·
              Warrants
                  to purchase 22,222,222 shares at an exercise price of $0.35 per
                  share
                  granted to purchasers of the Series B Preferred
                  Stock.
 ·
              Warrants
                  to purchase 606,951 shares at an exercise price of $0.35 granted
                  to note
                  holders in connection with the modification of convertible debt
                  terms.
 ·
              Warrants
                  to purchase 1,388,889 shares at an exercise price of $0.50 per
                  share, and
                  1,388,889 shares of common stock at an exercise price of $0.75
                  per share
                  in connection with a $250,000 bridge financing
                  agreement.
 ·
              Warrants
                  to purchase 87,500 shares granted to the Company’s President and CEO at an
                  exercise price of $0.35 per share in connection with an agreement
                  to
                  relinquish 562,500 previously issued
                  warrants.
 
 During
        the six months ended June 30, 2006 the Company recorded the cancellation
        of
        1,187,500 warrants to purchase common stock at an exercise price of $0.40
        held
        by the Company’s President and CEO.


16





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**7.
        **WARRANTS
        AND DERIVATIVE LIABILITY******(continued)**




In
      accordance with the provisions of EITF-00-19, “Accounting for Derivative
      Instruments Indexed to and Potentially Settled in, a Company’s own Stock,” the
      fair value of warrants to purchase common stock issued in connection with the
      Preferred Stock, and all other issued and outstanding warrants, have been
      classified as derivative liabilities .  Allocation
      of proceeds from the Preferred Stock financing resulted in the recording of
      $3,590,050 as an increase to the derivative liability.  The
      fair
      value of previously issued and outstanding warrants, as measured on the issuance
      date, $2,751,242, was reclassified from additional paid-in capital to derivative
      liabilities. The measurement of fair value of the warrants on June 30, 2006
      was
      $7,953,902. The consequent change of $1,612,610 between the measurement dates
      in
      the value of the warrants required an increase in the derivative liability
      and a
      derivative loss in the amount of $1,612,610.





**8.
        **CONVERTIBLE
        NOTES PAYABLE****




On
      April
      22, 2006 the holders of convertible notes with an aggregate principal balance
      of
      $4,750,000 agreed to extend the term of the notes until May 31, 2006 and to
      convert the notes into common shares at $0.18 per share, instead of $0.20.
      Viking has agreed to register with the Securities and Exchange Commission and
      applicable state securities agencies, the shares of common stock that are
      issuable upon the conversion of the notes and the shares of common stock that
      underlie the warrants.





In
      April
      2006, the Company received $250,000 through the issuance of a convertible
      note.  The note accrued interest at 10% per annum and was unsecured. In May
      2006, the noteholder converted the note into 250 shares of Series B Preferred
      Stock. In connection with the issuance of this note, the Company recorded debt
      discount and additional paid in capital in the amount of $250,000 based on
      the
      intrinsic value of the beneficial conversion feature. The entire discount amount
      was amortized as other expense during the three months ended June 30,
      2006.





Concurrent
      with the closing of the Series B Preferred Stock transaction, note-holders
      converted $5,500,000 of debt into equity instruments: $4,750,000 of the notes
      were converted into 26,388,891 shares of common stock and $750,000 of the notes
      were converted into 750 shares of Series B Preferred Stock . Each
      share of the Series B Stock is convertible, subject to adjustments, into
      approximately 5,555 shares of common and 2,778 warrants to purchase common
      stock.





In
      April
      2006 the Company and note holders agreed to modify certain terms of convertible
      notes totaling $5,250,000. The revised conversion terms were sufficiently
      different from the initial conversion terms of the notes, requiring the Company
      to account for the change in conversion terms
      as
      a substantial modification of terms in accordance with EITF Issue No. 96-19,
      “Debtor’sAccounting
      and Modification on Exchange of Debt Instruments”.





17





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





8. CONVERTIBLE
      NOTES PAYABLE (continued)




The
      original notes converted into common stock at a rate of $0.20 per share with
      25%
      warrant coverage with warrants to purchase common stock exercisable at $0.40
      per
      share. The new terms provided conversion into common stock at $0.18 per share
      and 25% warrant coverage with warrants to purchase common stock exercisable
      at
      $0.35 per share. As a result, the Company recorded a $4,975,824 gain on debt
      extinguishment in the current quarter representing the difference between the
      deemed reacquisition value of the convertible notes on the date the conversion
      terms were modified ($5,250,000) less the fair value of the modification of
      the
      warrants issued under the new conversion terms ($274,176). Upon conversion
      of
      this $5,250,000 in convertible notes, the Company issued 26,388,891 shares
      of
      common stock and 6,694,451 warrants to purchase shares of common stock.





**9.
        **COMMON
        STOCK****




During
      the quarter ended June 30, 2006 the Company increased the number of authorized
      shares of common stock from 150,000,000 to 200,000,000. In addition, during
      the
      quarter, the Company recorded the issuance of 55,000 shares in connection with
      a
      consulting agreement entered into in June 2005. The Company also entered into
      an
      agreement with its Investor Relations firm to issue up to 250,000 shares at
      a
      quarterly rate of 62,500 shares, with the first issuance scheduled to be made
      on
      August 31, 2006.




**10.
        **RELATED
        PARTY TRANSACTIONS****


During
      the six months ended June 30, 2006, Viking Systems


**·**
            Converted
                a $450,000 related party note payable to Donald E. Tucker, a significant
                shareholder, and the Company’s President and CEO, into 2,500,000 shares of
                common stock.**·**
            Had
                an unsecured note payable to Donald E. Tucker, a significant shareholder,
                and the Company’s President and CEO, in the amount of $200,000. This note
                was repaid on June 14, 2006.**·**
            Issued 87,500 warrants to purchase common stock
                at an
                exercise price of $0.35 per share to Donald E. Tucker, a significant
                shareholder, and the Company's President and CEO.**·**
            Cancelled 1,187,500 warrants to purchase common
                stock
                at an exercise price of $0.40 per share that were previously issued
                to
                Donald E. Tucker, a significant shareholder, and the Company's President
                and CEO.


During
      the six months ended June 30, 2005, Viking Systems


·
            Issued
                1,291,650 shares of common stock to Donald E. Tucker, a significant
                shareholder, and the Company’s President and CEO upon conversion of
                related party convertible notes payable of $500,000 and interest
                of
                $16,660.**·**
            Had
                convertible notes payable at June 30, 2005 to Donald E. Tucker, a
                significant shareholder, and the Company’s President and CEO, totaling
                $950,000.





18





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**·**
            Entered
                into a Loan and Security Agreement with Silicon Valley Bank. The
                Loan
                Agreement provided for a maximum borrowing of $200,000 and was secured
                by
                the assets of Viking Systems. The loan was also secured by a $200,000
                certificate of deposit owned by Donald E. Tucker, a significant
                shareholder, and the Company’s President and
                CEO.





**11.
        **SUBSEQUENT
        EVENTS****




During
      2005, Viking issued Convertible Promissory Notes (“Notes”) to certain accredited
      investors. Each of these investors was also issued a warrant to purchase shares
      of Viking common stock. In May 2006, each of the Note holders converted their
      Notes into shares of Viking common stock. In April 2006, Viking agreed to file,
      prior to June 21, 2006, a registration statement covering the shares of common
      stock issued upon the conversion of $4,450,000 of the Notes and shares of common
      stock underlying the warrants of these former Note holders. As a result of
      the
      required terms of the recently completed Series B Preferred Stock transaction,
      we were unable to include the securities of the former Note holders in the
      first
      registration statement. We anticipate a registration statement covering
      the Securities of these investors will be filed during the third or
      fourth quarter of 2006.





On
      July
      26, 2006, we received a letter from one of the of the Note purchasers whose
      shares had been converted into common stock. Such letter claimed that because
      we
      did not file a registration statement covering their shares, its conversion
      was
      null and void and its previous loan amount, $1,500,000 was immediately due
      and
      payable and would accrue interest until paid at the rate of 15% per cent per
      annum. This letter was subsequently withdrawn by such Note
      purchaser.





We
      have
      agreed to pay all Note purchasers, who elect to receive it, a registration
      delay
      fee of one percent per month of their initial Note principal balance. The delay
      fee began on June 21, 2006 and terminates on the date the Securities and
      Exchange Commission declares effective a registration statement covering the
      securities of the Note purchasers. Based on this agreement, we have accrued
      a
      liability of $10,200 for such fees as of June 30, 2006.





Effective
      July 25, 2006, we changed our domicile from the State of Nevada to the State
      of
      Delaware by way of a reincorporation merger. Our Certificate of Incorporation
      and Bylaws as a Delaware corporation are similar to the Articles of
      Incorporation and Bylaws we had as a Nevada Corporation.





19





**ITEM
      2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF** **FINANCIAL
      CONDITION AND RESULTS OF OPERATIONS**





In
      this
      report references to "Viking," "we," "us," "our" and the “Company” refer to
      Viking Systems, Inc.





**Overview**





** Viking
      Systems, Inc. designs, manufactures, and markets FDA cleared high performance
      laparoscopic vision systems. Viking’s primary product is the EndoSite 3Di
      Digital Vision System (the “EndoSite 3Di System”), an advanced three dimensional
      (“3-D”) vision system used by surgeons for complex minimally invasive
      laparoscopic surgery, with an initial focus on applications in urology,
      bariatrics, and laparoscopic gynecology. Viking Systems also manufactures
      advanced two dimensional (“2-D”) digital cameras that are sold through strategic
      partner and Original Equipment Manufacture (“OEM”) programs.





Viking’s
      technology and know-how center on its core technical competencies in optics,
      digital imaging, sensors, surgical robotics, and image management. Viking’s
      focus is to deliver advanced integrated information, visualization, and control
      solutions to the surgical team, enhancing their capability and performance
      in
      complex, minimally invasive surgical procedures.





Viking’s
      proprietary solutions for surgery are based on three principles:





·
            That
                3-D vision, providing natural depth perception and a clear view of
                a
                patient’s anatomy, is superior in facilitating the performance of complex
                surgical tasks;**·**
            That
                a Head Mounted Display, or HMD is a more ergonomic display solution
                for
                surgeons and interventional physicians than conventional video monitors;
                and**·**
            That
                integrating additional information in a voice controlled,
                picture-in-picture format into the surgeon’s view, in conjunction with the
                anatomical view, can facilitate decision making during
                surgery.





As
      of
      August 17, 2006, we had an installed base of more than twenty 3-D vision systems
      worldwide and more than 500 2-D digital cameras with OEM partners, including
      Boston Scientific Corporation (“Boston Scientific”, NYSE: BSX) and Medtronic,
      Inc. (“Medtronic”, NYSE: MDT). The list price for products range from $125,000
      to $200,000 for EndoSite 3Di Systems and from $3,000 to $27,000 for 2-D digital
      cameras and components.





Effective
      July 25, 2006, we changed our domicile from the State of Nevada to the State
      of
      Delaware by way of a reincorporation merger. Our Certificate of Incorporation
      and Bylaws as a Delaware corporation are similar to the Articles of
      Incorporation and Bylaws we had as a Nevada Corporation.





20





**Critical
      Accounting Policies**





This
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations discuss Viking Systems’ 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 and stock based compensation. Management
      bases its estimates and judgments on historical experience of the 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.*** Viking
      Systems reduces the stated value of its 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 Viking Systems’ net deferred tax assets,
      Viking Systems 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, Viking Systems may record a reduction in the valuation allowance,
      resulting in an income tax benefit in Viking Systems’ Statements of Operations.
      Management evaluates the realizability of the deferred tax assets and assesses
      the valuation allowance quarterly.





***Other
      Long-Lived Asset Valuations.*** Long-lived
      assets such as property, equipment and definite-lived intangibles are reviewed
      for impairment whenever events or changes in circumstances indicate that the
      carrying value of an asset may not be recoverable. 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 six months ended June 30, 2006 no impairment of
      long-lived assets was recorded.





21





***Revenue
      Recognition*** .
      Viking
      Systems’ revenues are derived from the sale of surgical visualization technology
      products to end users, distributors and original equipment manufactures. Revenue
      from the sale of products is recognized when a purchase order has been received,
      the system has been shipped, the selling price is fixed or determinable, and
      collection is reasonably assured. Most system sales are F.O.B. shipping point,
      therefore shipment is deemed to have occurred when the product is delivered
      to
      the transportation carrier. Most of Viking Systems’ sales through March 31, 2006
      have been for products that did not include installation services. 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. Some sales of systems may include training as
      part
      of the sale. In such cases, the portion of the revenue related to the training,
      calculated based on the amount that would be charged for training on a
      stand-alone basis, is deferred and recognized when the training has been
      provided. The sales of products do not require specific customer acceptance
      provisions and do not include the right of return except in cases where the
      product does not function as guaranteed by Viking Systems. To date, returns
      have
      not been significant. Shipping and handling costs are included in cost of
      sales.





***Stock-Based
      Compensation.*** On
      January 1, 2006 the Company adopted Statement of Financial Accounting Standards
      (“SFAS”) No.123 (Revised 2004), “Share Based Payment,” (“SFAS 123”), using the
      modified prospective method. In accordance with SFAS 123, 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.




***Valuation
      of Derivative Liabilities.***  At
      each
      subsequent balance sheet date, the fair value of all warrants will be
      remeasured, and any changes in the fair value will be recorded as a gain or
      loss
      on derivatives in the statement of operations.





**Recent
      Accounting Pronouncements**





In
      February 2006, the Financial Accounting Standards Board (“FASB”) released
      Statement No. 155, Accounting for Certain Hybrid Financial Instruments,
      ("SFAS No. 155"). SFAS No.155 is an amendment of Statement
      No. 133, Accounting for Derivative Instruments and Hedging Activities, and
      Statement No. 140, Accounting for Transfers and Servicing of Financial
      Assets and Extinguishments of Liabilities. SFAS No. 155 establishes, among
      other items, the accounting for certain derivative instruments embedded within
      other types of financial instruments; and, eliminates a restriction on the
      passive derivative instruments that a qualifying special-purpose entity may
      hold. Effective for the Company beginning January 1, 2007, SFAS
      No. 155 is not expected to have any impact on the Company's financial
      position, results of operations or cash flows.





22





In
      March 2006, the FASB released Statement No. 156, Accounting for
      Servicing of Financial Assets, an amendment of FASB Statement No. 140,
      ("SFAS No. 156"). SFAS No. 156 amends SFAS No. 140 to require
      that all separately recognized servicing assets and liabilities in accordance
      with SFAS No. 140 be initially measured at fair value, if practicable.
      Furthermore, this standard permits, but does not require, fair value measurement
      for separately recognized servicing assets and liabilities in subsequent
      reporting periods. SFAS No. 156 is also effective for the Company beginning
      January 1, 2007; however, the standard is not expected to have an impact on
      the Company's financial position, results of operation or cash flows.





In
      the
      first quarter of 2006, the Company adopted Statement No. 154, Accounting
      for Changes and Error Corrections—a replacement of APB Opinion No. 20 and
      FASB Statement No. 3 , ("SFAS No. 154") which changed the requirements
      for the accounting for and reporting of a voluntary change in accounting
      principle. The Company also adopted Statement No. 151, Inventory Costs—an
      amendment of ARB No. 43, Chapter 4 ("SFAS No. 151") which, among other
      changes, requires certain abnormal expenditures to be recognized as expenses
      in
      the current period versus capitalized as a component of inventory. The adoption
      of SFAS No. 154 did not impact the results presented and the impact on any
      future periods will depend on the nature and significance of any future
      accounting changes subject to the provisions of the statement. The adoption
      of
      SFAS No. 151 did not have any impact on the Company's financial position,
      results of operations or cash flows.





In
      June
      2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in
      Income Taxes - an interpretation of FASB Statement No. 109," (FIN 48). FIN
      48
      clarifies the accounting for uncertainty in tax positions and requires that
      a
      Company recognize in its financial statements the impact of a tax position,
      if
      that position is more likely than not of being sustained on audit, based on
      the
      technical merits of the position. The provisions of FIN 48 are effective for
      fiscal years beginning after December 15, 2006. The adoption of FIN 48 is not
      expected to have any impact on the Company's financial position, results of
      operations or cash flows.





**RESULTS
      OF OPERATIONS**





**Three
      Month and Six Month Periods Ended June 30, 2006 Compared to the Three and Six
      Month Periods Ended June 30, 2005**





***Revenues.*** ** For
      the
      three months ended June 30, 2006, we had product sales $883,180 compared to
      product sales of $1,082,413 for the three months ended June 30, 2005. This
      represents a decrease of $199,233 or 18%. Sales to individual customers
      exceeding 10% or more of revenues in the three months ended June 30, 2006 were
      to three customers who accounted for 25.5%, 12.2%, and 11.5% of revenues,
      respectively. For the six months ended June 30, 2006, we had product sales
      of
      $2,138,024 compared to product sales of $1,958,816 for the six months ended
      June
      30, 2005. This represents an increase of $179,208 or 9%. Sales to individual
      customers exceeding 10% or more of revenues in the three months ended June
      30,
      2006 were to three customers who accounted for 19.6%, 18.3%, and12.3% of
      revenues, respectively.





23





***Gross
      Profit.*** We had
      gross profit of $140,357 or 16% of total revenues for the three months ended
      June 30, 2006 and gross profit of $275,988 or 25% of total revenues for the
      three months ended June 30, 2005, representing a decrease of $135,631. The
      decrease in gross profit during the second quarter of 2006 was due to decreased
      sales compared to the prior quarter and to a mix of lower margin product
      revenues. We had gross profit of $505,324 or 24% of total revenues for the
      six
      months ended June 30, 2006 and gross profit of $533,166 or 27% of total revenues
      for the six months ended June 30, 2005, representing a decrease of $27,842.
      The
      decrease in gross profit during the first half of 2006 was due to a mix of
      lower
      margin product revenues





***Sales
      and Marketing Expenses*** **.** Selling
      and Marketing expenses were $1,135,241 for the three months ended June 30,
      2006
      and $695,225 for the three months ended June 30, 2005. For the six months ended
      June 30, 2006 Selling and Marketing expenses were $2,009,609 compared to
      $1,169,043 for the six months ended June 30, 2005. The year-over-year increase
      in sales and marketing expenses was due to the increased efforts to develop
      market awareness and to build our sales organization for our 3Di products.
      We
      expect that our selling and marketing expenses will continue to increase as we
      establish our 3Di Systems business.





***Research
      and Development Expenses.*** ** Research
      and Development expenses were $314,036 for the three months ended June 30,
      2006
      and $235,904 for the three months ended June 30, 2005. For the six months ended
      June 30, 2006 Research and Development expenses were $624,260 compared to
      $427,280 for the six months ended June 30, 2005. The year-over-year increase
      is
      due to the continued development of our 3Di product line. We expect that our
      research and development expenses will remain at their current levels as we
      continue to develop, maintain and support our current products.





***General
      and Administrative Expenses.*** ** We had
      General and Administrative expenses of $684,434 for the three months ended
      June
      30, 2006 and $337,476 for the three months ended June 30, 2005. For the six
      months ended June 30, 2006 General and Administrative expenses were $1,213,624
      compared to $829,242 for the six months ended June 30, 2005. We expect that
      our
      General and Administrative expenses will increase from their current levels
      as
      we hire additional personnel, implement and document internal controls in
      connection with our efforts to become compliant with requirements of Section
      404
      of The Sarbanes - Oxley Act of 2002 and expend resources on the implementation
      of a new ERP system.





24





***Other
      Income and Expenses.*** We
      had
      interest income of $21,787 and a $4,975,824 gain on the extinguishment of debt
      for both the three months and the six months ended June 30, 2006. We had no
      such
      income in the comparable periods in 2005. Interest income in 2006 resulted
      from
      the proceeds of our recent preferred stock financing being deposited in interest
      bearing accounts. The gain on extinguishment of debt resulted from the
      difference between the deemed reacquisition value of the convertible notes
      on
      the date conversion terms were modified ($5,250,000) less the fair value of
      the
      modification of the warrants issued under new conversion terms ($274,176).
      We
      had non-cash amortization of debt discount expenses of $5,500,000 for the three
      months ended June 30, 2006 and amortization of debt discount expenses of
      $687,501 for the three months ended June 30, 2005, representing an increase
      of
      $4,812,499. Amortization of debt discount expenses for the six months ended
      June
      30, 2006 totaled $8,480,878 and for the six months ended June 30, 2005 were
      $754,033, representing an increase of $7,726,845. The increase is due primarily
      to the inclusion in 2006 of $5,250,000 in non-cash expense representing the
      deemed reacquisition value of convertible notes when their conversion terms
      were
      modified. For the three months and six months ending June 30, 2006 we also
      recognized the fair value of all the Company’s warrants with a non-cash
      derivative liability expense of $1,612,610.





***Net
      Income (Loss).*** We had a
      net loss of $4,268,937 for the three months ended June 30, 2006 and a net loss
      of $1,750,219 for the three months ended June 30, 2005, representing a
      year-over-year increase in our net loss of $2,518,718 for the second quarter
      of
      2006 compared to the second quarter of 2005. We had a net loss of $8,744,041
      for
      the six months ended June 30, 2006 and a net loss of $2,740,331 for the six
      months ended June 30, 2005, representing a year-over-year increase in our net
      loss of $6,003,710 for the second half of 2006 compared to the second half
      of
      2005.We incurred significant costs implementing our sales and marketing plan,
      developing and improving our 3Di product line, and maintaining operations of
      the
      Visualization business. During 2006 we also incurred $8,480,878 in non-cash
      interest expense related to the amortization of the debt discount on the
      Convertible Notes and $1,612,610 in non-cash derivative loss, partially offset
      by a $4,975,824 gain on the extinguishment of debt.





**LIQUIDITY
      AND CAPITAL RESOURCES**





We
      have
      financed our operations principally through private sales of equity securities
      and convertible notes. From January 1, 2004 through June 30, 2006, we have
      raised net proceeds of $8,150,000 through the sale of common and preferred
      stock
      in private placements, and $5,700,000 through the issuance of convertible
      promissory notes. As of June 30, 2006, we had cash, cash equivalents and
      short-term investments of $3,922,357 compared to $434,503 as of December 31,
      2005. We incurred operating losses in 2006 and 2005, and at June 30, 2006,
      had
      an accumulated deficit of approximately $18,588,181.





Net
      cash
      used in operating activities was $3,252,383 **** and
      $2,722,056 during the six months ended June 30, 2006 and June 30, 2005,
      respectively. The increase in net cash used in operating activities during
      2006
      compared to 2005 was attributable primarily to an investment in inventories
      and
      the increased operating expenses associated with expanding the Company’s
      business activities.





25





Net
      cash
      used in investing activities was $112,421 and $273,978 during the six months
      ended June 30, 2006 and June 30, 2005, respectively. The higher level of cash
      used in investing activities in 2005 was attributable to purchases of
      demonstration equipment of our 3Di product line in support of our sales and
      marketing efforts.





Cash
      flow
      provided by financing activities was $6,852,658 and $2,956,785 during the six
      months ended June 30, 2006 and June 30, 2005, respectively. The cash flows
      from
      financing activities in 2006 consisted of $6,813,858 in net proceeds from our
      preferred stock financing, $250,000 from notes payable, partially offset by
      a
      $211,200 reduction in short-term bank borrowings. In 2005 we received $2,850,000
      in proceeds from convertible notes payable and $106,785 in short-term bank
      borrowings.





We
      have a
      bank line of credit facility equal to 80% of our outstanding receivables up
      to a
      maximum of $400,000, which expires in September 2006 and is subject to annual
      renewals. As of June 30, 2006, we had no outstanding borrowing under this credit
      facility. Additionally, we are continuing our efforts to achieve profitability
      through increased sales and profit margins. There can be no assurance that
      we
      will be successful in our efforts to achieve profitable operations. If we are
      unable to do so we may be required to reduce operations, reduce or discontinue
      further research and development, and/or reduce or eliminate further acquisition
      activities.





During
      2005, Viking issued Convertible Promissory Notes (“Notes”) to certain accredited
      investors. Each of these investors was also issued a warrant to purchase shares
      of Viking common stock. In May 2006, each of the Note holders converted their
      Notes into shares of Viking common stock. In April 2006, Viking agreed to file,
      prior to June 21, 2006, a registration statement covering the shares of common
      stock issued upon the conversion of the Notes and shares of common stock
      underlying the warrants of these former Note holders. As a result of the
      required terms of the recently completed Series B Preferred Stock transaction,
      we were unable to include the securities of the former Note holders in the
      first
      registration statement. We anticipate a registration statement covering
      the Securities of these investors will be filed during the third or
      fourth quarter of 2006. Subsequent to the end of the quarter, we agreed to
      pay a
      delay fee to the note purchasers of one percent per month to those former Note
      holders who elect to receive a fee. The delay fee began on June 21, 2006 and
      terminates on the date the Securities and Exchange Commission declares effective
      a registration statement covering the securities of the Note purchasers. Given
      the former Note holders who have waived the fee to date, we expect the aggregate
      monthly delay fee to be no more than $34,000. We are unable to predict when
      the
      delay fee will terminate.





***Off-Balance
      Sheet Arrangements.*** We do
      not have any off balance sheet arrangements that are reasonably likely to have
      a
      current or future effect on our financial condition, revenues, results of
      operation, liquidity or capital expenditures.





26





**Forward
      Outlook and Risks**





This
      Form
      10-QSB contains and incorporates by reference certain “forward-looking
      statements” within the meaning of Section 27A of the Securities Act and Section
      21E of the Exchange Act with respect to results of our operations and
      businesses. All statements, other than statements of historical facts, included
      in this Form 10-QSB, 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. Because
      forward-looking statements involve risks and uncertainties, our actual results
      could differ materially. Important factors that could cause actual results
      to
      differ materially from our expectations are disclosed hereunder and elsewhere
      in
      this Form 10-QSB. These forward-looking statements represent our judgment as
      of
      the date of this Form 10-QSB. All subsequent written and oral forward-looking
      statements attributable to Viking are expressly qualified in their entirety
      by
      the Cautionary Statements. We disclaim, however, any intent or obligation to
      update our forward-looking statements.





***Possibility
      of Total Loss of Investment.*** An
      investment in the Company is an extremely high risk investment, and should
      not
      be made unless the investor has no need for current income from the invested
      funds and unless the investor can afford a total loss of his or her
      investment.





***Additional
      Financing Requirements.*** We will
      likely be required to seek additional financing in order to fund our operations
      and carry out our business plan. In order to fund our operations and effect
      additional acquisitions, we will be required to obtained additional capital.
      There can be no assurance that such financing will be available on acceptable
      terms, or at all 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.





***Report
      of Independent Registered Public Accounting Firm includes a Going Concern
      Explanatory Paragraph.*** The
      report of our Independent Registered Public Accounting Firm dated March 20,
      2006
      for the year ended December 31, 2005, included a going concern explanatory
      paragraph which stated that our significant operating losses and working capital
      deficit at December 31 2005 raise substantial doubt about our ability to
      continue as a going concern subsequent to the date of their report. We sold
      $7,250,000 of our Series B Preferred shares for cash. In addition, in connection
      with this financing, holders of our convertible notes payable converted notes
      into shares of common and preferred stock. We believe these transactions address
      the near-term liquidity concerns raised by our Independent Registered Public
      Accounting Firm.





27





**Medical
      Operations Risks**





***We
      Operate in a Competitive Market.*** The
      market for medical products and services is competitive and new offerings and
      technologies are becoming available regularly. We cannot guarantee that we
      will compete successfully against our potential competitors, especially those
      with significantly greater financial resources or brand name
      recognition.





***If
      We Fail to Retain Key Personnel and Hire, Train and Retain Additional Qualified
      and Experienced Employees, We May Not Be Able to Compete
      Effectively.*** **** Our
      future success will depend to a large extent on retaining our employees and
      recruiting sufficient qualified employees to fill vacancies created by attrition
      or expansion of our operations. There is likely to be a competitive labor market
      for such staff and there is no assurance that we will be able to attract and
      retain an adequate number of suitable employees.




***We
      Are Subject To Significant Domestic and International Regulation and May Not
      Be
      Able To Obtain Necessary Regulatory Clearances to Sell Our Products.*** **** We sell
      medical devices **.** 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
      Expect to Encounter Rapid Technological Change and Significant Competition.*** 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 microsurgery.





28





***Our
      Profitability is Directly Related to the Level Of Reimbursements for Surgical
      Procedures Using the Offered Products.*** **** Our
      profitability will be directly related to the level of payments for the surgical
      procedures, in which our products will be involved, either by Medicare or
      private insurance companies.  We could be adversely affected by changes in
      payment policies of government or private health care payors, 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 U.S. 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 payors, such as governmental programs and private
      insurance plans, for the health care services provided to their patients. 
Third-party payors 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 payor, 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 payors 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
      payors.




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 and
      significant 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.





29





**ITEM
      3. CONTROLS AND PROCEDURES**


**EVALUATION
      OF DISCLOSURE CONTROLS AND PROCEDURES**





(a)  Evaluation
        of Disclosure Controls and Procedures




Based
      on
      their evaluations as of June 30, 2006, the principal executive officer and
      principal financial officer of the Company have concluded that the Company's
      disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
      under the Securities Exchange Act) are not effective to ensure that information
      required to be disclosed by the Company in reports that the Company files or
      submits under the Securities Exchange Act is recorded, processed, summarized
      and
      reported within the time periods specified in the rules and forms of the
      SEC.





(b)  Changes
      in Internal Controls





There
      were no significant changes in the Company's internal controls over financial
      reporting or in other factors that could significantly affect these internal
      controls subsequent to the date of their most recent evaluation, including
      any
      corrective actions with regard to significant deficiencies and material
      weaknesses.





**PART
      II - OTHER INFORMATION**





Item
      1.  Legal
      Proceedings .
      We are
      not a party to any legal proceeding.





Item
      2.  Unregistered
      Sales of Equity Securities .
      During
      the quarter ended June 30, 2006, we issued 26,388,891 shares of our common
      stock
      in an unregistered transaction. Such shares were issued in connection with
      the
      conversion of convertible promissory notes into shares of our common stock
      at
      the price of $.18 per share On May 22, 2006, we issued 8,000 shares of our
      Series B Preferred Stock for aggregate consideration of $8,000,000. Such shares
      of common stock and Series B Preferred Stock were not registered and were issued
      in reliance on Section 4(2) of the Securities Act of 1933, as
      amended.





Item
      3.  Defaults
      by the Company on its Senior Securities .
      None





Item
      4.  Submission
      of Matters to Vote of Security Holders .
      On May
      22, 2006 the holder of 27,121,150 shares of our common stock out of the
      35,418,550 shares of common stock issued and outstanding consented in writing
      to
      a proposal to change our domicile from the state of Nevada to the State of
      Delaware and to amend our Articles of Incorporation to increase the number
      of
      shares of common stock which we are authorized to issue from 150,000,000 to
      200,000,000. This consent was obtained in lieu of holding a Meeting of
      Shareholders. A Preliminary Information Statement and a Final Information
      Statement on Schedule 14(c) were filed with the Securities and Exchange
      Commission in connection with such written consent and we effected the amendment
      to increase our authorized shares. The change of domicile and increase in
      authorized shares were effective as of July 25, 2006.





30





Item
      5.  Other
      Information .





**Loan
      Guarantee Collateral**





On
      January 27, 2005, we entered into a Loan and Security Agreement with Silicon
      Valley Bank. The Loan Agreement provides for a maximum borrowing of $200,000.
      The loan was secured by the assets of the Company. The loan was also secured
      by
      a $200,000 certificate of deposit owned by Donald Tucker, a significant
      shareholder and the Company’s President and Chief Executive Officer. We
      terminated the Loan and Security Agreement on June 6, 2006.





31





Item
                6. Exhibits.
            31.1
                Certification by the Chief Executive Officer pursuant to Section
                302 of
                the Sarbanes-Oxley Act of 2002.31.2
                Certification by the Chief Financial Officer pursuant to Section
                302 of
                the Sarbanes-Oxley Act of 2002.





32.1
                Certification by the Chief Executive Officer pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002.32.2
                Certification by the Chief Financial Officer pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002.








SIGNATURE





In
      accordance with the requirements of the Exchange Act, the Company has caused
      this report to be signed on its behalf by the undersigned thereunto duly
      authorized.





Dated:
                August 21, 2006
            VIKING
                SYSTEMS, INC.By/s/
                Donald
                TuckerChief Executive Officer, PresidentBy/s/
                Gregory M.
                DeckerChief Financial Officer




32