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 September 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 ofincorporation
                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




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





Common
      Stock outstanding on September 30, 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 September 30, 2006**







**PART
      I - FINANCIAL INFORMATION**


Page
                ofForm
                10-QSBItem
                1.
            Financial
                Statements (unaudited):Balance
                Sheets at September 30, 2006 and December
                31, 2005
            3Statements
                of Operations for the Three and Nine Months
                Ended September 30, 2006 and 2005
            4Statements
                of Cash Flows for the Nine Months Ended
                September 30, 2006 and 2005
            5-6Notes
                to Financial Statements
            7 -
                17Item
                2.
            Management's
                Discussion and Analysis of Financial Condition
                and Results of Operations
            18Item
                3.
            Controls
                and Procedures, Evaluation of Disclosure Controls
                and Procedures
            24




**PART
      II - OTHER INFORMATION**




PageItem
                1.
            Legal
                Proceedings
            24Item
                2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            24Item
                3.
            Defaults
                Upon Senior Securities
            24Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            24Item
                5.
            Other
                Information
            24Item
                6.
            Exhibits
            24








2


**PART
        I - FINANCIAL INFORMATION**
 **ITEM
        1: FINANCIAL STATEMENTS**
 **VIKING
        SYSTEMS, INC.**
 **Balance
        Sheets - Unaudited**
 **September
                    30,**
                  **2006**
                
                **December
                    31, 2005****Assets**Current
                    assets:Cash
                    and cash equivalents
                
                $
                1,836,595
                
                $
                434,503Accounts
                    receivable, net
                
                
                911,850
                
                
                248,258Inventories
                
                
                1,345,806
                
                
                567,176Prepaid
                    expenses
                
                
                15,708
                
                
                48,148Other
                    current assets
                
                
                84,049
                
                
                34,789Total
                    current assets
                
                
                4,194,008
                
                
                1,332,874Property
                    and equipment, net
                
                
                519,487
                
                
                377,632Total
                    Assets
                
                $
                4,713,495
                
                $
                1,710,506**Liabilities
                    and Stockholders' Deficit**Current
                    liabilities:Accounts
                    payable
                
                $
                859,152
                
                $
                515,781Accrued
                    payroll and related expenses
                
                
                229,067
                
                
                230,773Accrued
                    royalties
                
                
                163,450
                
                
                84,658Other
                    accrued expenses
                
                
                345,132
                
                
                112,916Deferred
                    revenue
                
                
                68,844
                
                
                -Short-term
                    bank borrowings
                
                
                395,873
                
                
                211,200Short
                    term capital leases
                
                
                36,235
                
                
                -Related
                    party convertible notes payable
                
                
                -
                
                
                766,918Convertible
                    notes payable net of debt discount
                
                
                -
                
                
                1,502,158Derivative
                    liability
                
                
                4,404,063
                
                
                -Total
                    current liabilities
                
                
                6,501,816
                
                
                3,424,404Long
                    term liabilitiesCapital lease obligations
                
                
                87,404
                
                
                -Commitments
                    and contingenciesSeries
                    B preferred stock, $0.001 par value; 8,000 shares authorized,
                    issued and
                    outstanding at September 30, 2006. No shares authorized, issued
                    and
                    outstanding at December 31, 2005 (aggregate liquidation preference
                    of
                    $8,229,699 and $0 at September 30, 2006 and December 31, 2005,
                    respectively)
                
                
                8,229,699
                
                
                -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 September
                    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 September 30, 2006
                    and
                    December 31, 2005, respectively.
                
                
                61,865
                
                
                34,528Additional
                    paid-in capital
                
                
                6,919,644
                
                
                8,095,714Accumulated
                    deficit
                
                
                (17,086,933
                )
                
                (9,844,140
                )Total
                    stockholders' deficit
                
                
                (10,105,424
                )
                
                (1,713,898
                )Total
                    liabilities and stockholders' deficit
                
                $
                4,713,495
                
                $
                1,710,506
   See
        accompanying notes to financial statements
 3
  **VIKING
        SYSTEMS, INC.**
 **Statements
        of Operations****-****-****Unaudited**
  **Three
                    Months Ended**
                
                **Nine
                    Months Ended****September
                    30,**
                
                **September
                    30,****2006**
                
                **2005**
                
                **2006**
                
                **2005**Sales,
                    net
                
                $
                1,514,591
                
                $
                1,117,806
                
                $
                3,652,615
                
                $
                3,076,622Cost
                    of sales
                
                
                1,012,554
                
                
                797,936
                
                
                2,645,254
                
                
                2,223,586Gross
                    profit
                
                
                502,037
                
                
                319,870
                
                
                1,007,361
                
                
                853,036Operating
                    expenses:General
                    and administrative
                
                
                706,777
                
                
                418,928
                
                
                1,920,401
                
                
                1,248,172Selling
                    and marketing
                
                
                1,311,849
                
                
                734,915
                
                
                3,321,458
                
                
                1,903,956Research
                    and development
                
                
                445,023
                
                
                242,421
                
                
                1,069,283
                
                
                669,701Total
                    operating expenses
                
                
                2,463,649
                
                
                1,396,264
                
                
                6,311,142
                
                
                3,821,829Operating
                    loss
                
                
                (1,961,612
                )
                
                (1,076,394
                )
                
                (5,303,781
                )
                
                (2,968,793
                )Other
                    income (expense):Interest
                    income
                
                
                31,147
                
                
                -
                
                
                52,934
                
                
                -Interest
                    expense
                
                
                (118,126
                )
                
                (79,059
                )
                
                (424,121
                )
                
                (172,958
                )Gain
                    on extinguishment of debt
                
                
                -
                
                
                -
                
                
                4,975,824
                
                
                -Amortization
                    of debt discount
                
                
                -
                
                
                (924,590
                )
                
                (8,480,878
                )
                
                (1,678,623
                )Gain
                    on derivative liability
                
                
                3,549,839
                
                
                -
                
                
                1,937,229
                
                
                -Net
                    income (loss)
                
                $
                1,501,248
                
                $
                (2,080,043
                )
                $
                (7,242,793
                )
                $
                (4,820,374
                )Accretion
                    of Series B Preferred Stock to redemption value including dividend
                    accrued
                
                
                (161,315
                )
                
                -
                
                
                (8,229,699
                )
                
                -Net
                    income (loss) applicable to common stockholders
                
                $
                1,339,933
                
                $
                (2,080,043
                )
                $
                (15,472,492
                )
                $
                (4,820,374
                )Basic
                    earnings (loss) per share
                
                $
                0.02
                
                $
                (0.06
                )
                $
                (0.32
                )
                $
                (0.15
                )Basic
                    weighted average shares
                
                
                61,864,941
                
                
                33,403,000
                
                
                47,769,802
                
                
                32,027,000Diluted
                      earnings (loss) per common share
                
                $
                0.01
                
                $
                (0.06
                )
                $
                (0.32
                )
                $
                (0.15
                )Diluted
                    weighted average shares
                
                
                106,536,537
                
                
                33,403,000
                
                
                47,769,802
                
                
                32,027,000
 See
        accompanying notes to financial statement s
 4
  **VIKING
        SYSTEMS, INC.**
 **Unaudited
        Statements of Cash Flows for the Nine Months ended
        September 30**
  **2006**
                
                **2005****Cash
                    flows from operating activities:**Net
                    loss
                
                $
                (7,242,793
                )
                $
                (4,820,374
                )Adjustment
                      to reconcile net loss to net cash used in operating
                      activities:Depreciation
                    and amortization
                
                
                279,859
                
                
                188,114Common
                    stock issued for services
                
                
                44,041
                
                
                101,694Stock
                    based compensation expense
                
                
                540,229
                
                
                22,000Amortization
                    of debt discount
                
                
                8,480,878
                
                
                1,678,623Gain
                    on extinguishment of debt
                
                
                (4,975,824
                )
                
                -Gain
                    on derivative liability
                
                
                (1,937,229
                )
                
                -Change
                    in operating assets and liabilities:Accounts
                    receivable, net
                
                
                (663,592
                )
                
                (492,103
                )Inventories,
                    net
                
                
                (754,259
                )
                
                165,491Prepaid
                    expenses
                
                
                32,440
                
                
                57,408Other
                    current assets
                
                
                (49,260
                )
                
                -Accounts
                    payable
                
                
                343,371
                
                
                (778,713
                )Accrued
                    salaries and related expenses
                
                
                (1,706
                )
                
                -Accrued
                    royalties
                
                
                78,792
                
                
                -Other
                    accrued expenses
                
                
                232,216
                
                
                200,929Deferred
                    revenue
                
                
                68,844
                
                
                (159,150
                )Net
                    cash used in operating activities
                
                
                (5,523,993
                )
                
                (3,836,081
                )**Cash
                    flows from investing activities:**Purchase
                    of property and equipment
                
                
                (322,446
                )
                
                (358,520
                )Net
                    cash used in investing activities
                
                
                (322,446
                )
                
                (358,520
                )
 
 **Cash
                    flows from financing activities:**Net
                    change in short-term bank borrowings
                
                
                184,673
                
                
                366,471Proceeds
                    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
                
                
                3,750,000Net
                    cash provided by financing activities
                
                
                7,248,531
                
                
                4,216,471Net
                    increase in cash and cash equivalents
                
                
                1,402,092
                
                
                21,870Cash
                    and cash equivalents at beginning of period
                
                
                434,503
                
                
                139,393Cash
                    and cash equivalents at end of period
                
                $
                1,836,595
                
                $
                161,263**Supplemental
                    disclosure of cash flow information:**Cash
                    paid during the period for:Interest
                
                $
                332,754
                
                $
                79,060Income
                    taxes
                
                $
                -
                
                $
                -
  See
        accompanying notes to financial statements


5




**Non-Cash
      Investing and Financing Activity**


*Nine
      months ended September 30, 2006:*





During
      the nine months ended September 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**·**
            Acquired
                computer equipment and software through capital leases in the amount
                of
                $123,639





*Nine
      months ended September 30, 2005:*





During
      the nine months ended September 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.**·**
            Converted
                a $500,000 note payable into 2,500,000 shares of common
                stock.**·**
            Recorded
                deferred compensation of $88,000 for common stock issued with a consulting
                agreement.





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
      September 30, 2006 and the statements of operations and cash flows for the
      nine
      months ended September 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 nine months ended September 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
      nine-months ended September 30, 2006 the Company generated net proceeds of
      approximately $7.2 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.
      EARNINGS (LOSS) PER SHARE**





The
      following table illustrates the calculation of basic and diluted earnings (loss)
      per common share:


For
                  the three
                months
                ended
                September
                  30,
                2006
              
              For
                  the three
                months
                ended
                September
                  30,
                2005
              
              For
                  the nine
                months
                ended
                September
                  30,
                2006
              
              For
                  the nine
                months
                ended
                September
                  30,
                2005BasicNet
                  income (loss) applicable to common stockholders
              
              $
              1,339,933
              
              $
              (2,080,043
              )
              $
              (15,472,492
              )
              
              $
                  (4,820,374
              )Basic
                  weighted average shares
              
              
              61,864,941
              
              
              33,403,000
              
              
              47,769,802
              
              
              32,027,000Basic
                  earnings (loss) per share
              
              $
              0.02
              
              $
              (0.06
              )
              $
              (0.32
              )
              $
              (0.15
              )Diluted
                
                Net
                  income (loss) applicable
              
              
              1,501,247
              
              $
              (2,080,043
              )
              $
              (15,472,492
              )
              $
              (4,820,374
              )Weighted
                  average common shares outstanding
              
              
              61,864,941
              
              
              33,403,000
              
              
              47,769,802
              
              
              32,027,000Add:
                
                Conversion
                  of Preferred Series B
              
              
              44,444,444
              
              
              -
              
              
              -
              
              
              -Exercise
                  of stock options
              
              
              227,152
              
              
              -
              
              
              -
              
              
              -Diluted
                  weighted average shares
              
              
              106,536,537
              
              
              33,403,000
              
              
              47,769,802
              
              
              32,027,000Diluted
                  earnings (loss) per common share
              
              $
              0.01
              
              $
              (0.06
              )
              $
              (0.32
              
              $
              (0.15
              )




Due
      to
      the net losses for the three months ended September 30, 2005 and nine month
      ended September 30, 2006 and 2005, potentially dilutive securities have been
      excluded in the calculation of diluted loss per share because their inclusion
      would be anti-dilutive. Accordingly, basic and diluted loss per share for the
      three month period ended September 30, 2005 and nine month periods presented
      are
      the same. Additionally, there were no dividends paid during these reporting
      periods.




Options
      to purchase 4,991,000 shares of common stock were outstanding during the three
      months ended September 30, 2006 but were not included in the computation of
      diluted earnings per share because the option exercise price was greater than
      the average market price of the common shares and therefore, the effect would
      be
      anti-dilutive.





8





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**







**4.
      INVENTORY**




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




**September
                  30, 2006**
              
              **December
                  31, 2005**Inventories:Parts
                  and supplies
              
              $
              526,055
              
              $
              292,277Work-in-progress
              
              
              284,644
              
              
              150,016Finished
                  goods
              
              
              535,107
              
              
              124,883$
              1,345,806
              
              $
              567,176





**5.
      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 nine month periods ended September 30, 2006, the Company recorded $82,801
      and $325,165 respectively, in non-cash stock-based compensation expense related
      to the implementation of SFAS 123R. As of September 30, 2006, there was
      approximately $796,943 of total unrecognized compensation costs related to
      unvested options, which is expected to be recognized over a weighted average
      period of approximately 8.65 years.





The
      fair
      value of stock options at date of grant was estimated using the Black-Scholes
      model with the following assumptions: expected volatility ranging from 76.89%
      to
      89.25%, expected term of 10 years, risk-free interest rate ranging from 4.30%
      to
      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.





9





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**







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




The
      following table summarizes the stock option transactions during the nine months
      ended September 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
              
              
              2,800,000
              
              
              0.37
              
              
              8.94Exercised
              
              
              (1,000,000
              )
              
              0.02
              
              
              -Cancelled
              
              
              (590,000
              )
              
              0.50
              
              
              -Options
                  outstanding September 30, 2006
              
              
              6,916,000
              
              
              0.43
              
              
              6.75Options
                  exercisable at September 30, 2006
              
              
              3,768,000
              
              
              0.43
              
              
              5.61


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:


For
                  the three months ended September 30, 2005
              
              For
                  the nine months ended September 30, 2005Net
                  loss as reported
              
              $
              (2,080,043
              )
              $
              (4,820,374
              )Deduct:
                  Total stock-based employee compensation expense determined under
                  fair
                  value based method for all awards, net of related tax
                  effects
              
              
              (38,425
              )
              
              (76,850
              )Pro
                  forma net loss
              
              $
              (2,118,468
              )
              $
              (4,897,224
              )Basic
                  and diluted loss per share - as reported
              
              $
              (0.06
              )
              $
              (0.15
              )Basic
                  and diluted loss per share - proforma
              
              $
              (0.06
              )
              $
              (0.15
              )




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
              4.17%Dividend
                  yield
              -Volatility
              161.48%





10




**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**







**6.
      RECENT ACCOUNTING PRONOUNCEMENTS**





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
(“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for
      measuring fair value, and expands disclosures about fair value measurements.
      This Statement focuses on creating consistency and comparability in fair value
      measurements. SFAS No. 157 is effective for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years.  We
      are currently evaluating the impact of adopting SFAS 157 on our financial
      statements.





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 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
      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.





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.





**7.
      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 (“Stated Value”), 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.





The
      Company applied 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”).





11




**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**







**7.
      SERIES B CONVERTIBLE PREFERRED STOCK** (continued)





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 nine month periods ended September 30, 2006.




Convertible
                  preferred stock
              
              $
              8,000,000Less:Issuance
                  costs
              
              
              436,142Fair
                  value of warrants
              
              
              3,590,050Beneficial
                  conversion feature
              
              
              3,973,808Subtotal
              
              $
              -Plus:Accrued
                  dividends
              
              
              229,699Accretion
                  of discount to redemption value
              
              
              8,000,000Convertible
                  preferred stock
              
              $
              8,229,699


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 charge to additional paid in capital and
      to
      the net loss attributable to common stockholders, amounting to $8,000,000 as
      of
      September 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:





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 nine month periods ended September 30, 2006, the Company recorded
      preferred stock dividends of approximately $161,315 and $229,699, respectively,
      as an increase to the net loss available to common stockholders in the
      accompanying consolidated statement of operations. All dividends accrued to
      date
      remain unpaid as of September 30, 2006. The Company may request that the
      preferred B shareholders consent to receive payment of dividends in shares
      of
      the Company’s stock.





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





12





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**







**7.
      SERIES B CONVERTIBLE PREFERRED STOCK** (continued)





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.





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.





13





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**







**7.
      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.





Our
      initial registration statement became effective within 90 days and a subsequent
      registration statement was recently filed and is currently being reviewed for
      approval with the Securities and Exchange Commission. The Company is currently
      in compliance with the effectiveness requirement of the registration rights
      agreement and does not currently have any liabilities for liquidated damages
      to
      the holders.





14





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**





**8.
      WARRANTS AND DERIVATIVE LIABILITY**




The
      following table summarizes warrants to purchase common stock outstanding as
      of
      September 30, 2006:


**Shares**
              
              **Range
                  of Exercise Prices**
              
              **Weighed
                  Average Exercise Prices**
              
              **Weighted
                  Average Remaining Contractual Life**Warrants
                  outstanding December 31, 2005
              
              
              7,187,500
              
              $
              0.40
              
              $
              0.40
              
              $
              3.10Granted
              
              
              25,684,722
              
              
              0.35
                  - 0.75
              
              
              0.38
              
              
              4.58Exercised
              
              
              -
              
              
              -
              
              
              -
              
              
              -Cancelled
              
              
              (1,187,500
              )
              
              0.40
              
              
              0.40
              
              
              2.67Warrants
                  outstanding September 30, 2006
              
              
              31,684,722
              
              $
              0.35
                  - 0.75
              
              $
              0.37
              
              $
              4.16


Included
      in the total of 25,684,722 warrants granted during the nine months ended
      September 30, 2006 to purchase common shares 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 nine months ended September 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.




Evaluation
      of criteria under Emerging Issues Task Force (“EITF”) Issue 00-19, “Accounting
      for Derivative Instruments Indexed to and Potentially Settled in, a Company’s
      own Stock,” resulted in the determination that the fair value of warrants to
      purchase common stock issued in connection with the Preferred Stock, and all
      other issued and outstanding warrants, should be classified as derivative
      liabilities. In accordance with EITF 00-19, warrants classified as
      derivative liabilities are marked to market value each reporting period with
      the
      corresponding non-cash gain or loss reflected in the current period. The fair
      value of the warrants on September 30, 2006 was $4,404,063 on September 30,
      2006
      and the change in fair value of $3,549,839 during the quarter ended September
      30, 2006 required an decrease in the derivative liability and a derivative
      gain
      in the amount of $3,549,839.





15





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**








**9.
      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’s Accounting and
      Modification on Exchange of Debt Instruments”.





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.





During
      2005, Viking issued Convertible Promissory Notes (“Notes”) to certain accredited
      investors, including $2,000,000 in the 4 th quarter
      of 2005. 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 $4,750,000 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 fourth
      quarter of 2006.





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 are accruing
      approximately $34,000 per month and as of September 30, 2006, we have accrued
      a
      total of $84,300 for such fees.





16





**VIKING
      SYSTEMS, Inc.**


**Notes
      to Financial Statements (Unaudited)**








**10.
      COMMON STOCK**




During
      the quarter ended September 30, 2006 the Company 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 expected to be made in the subsequent
      quarters.




**11.
      RELATED PARTY TRANSACTIONS**




During
      the nine months ended September 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 nine months ended September 30, 2005, Viking Systems





·
            Issued
                1,291,650 shares of common stock to Donald E. Tucker, a significant
                shareholder, and effective May 31, 2006, the Company’s President and CEO
                upon conversion of related party convertible notes payable of $500,000
                and
                interest of $16,659.**·**
            Had
                convertible notes payable at September 30, 2005 to Donald E. Tucker,
                a
                significant shareholder, and effective May 31, 2006, the Company’s
                President and CEO, totaling $200,000.**·**
            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 since May 31, 2006, the Company’s President and
                CEO.







17





**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
      September 30, 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.





**Use
      of Estimates and 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 and derivative
      liabilities. 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.





18





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 nine months ended September 30, 2006 no impairment
      of long-lived assets was recorded.





***Revenue
      Recognition*** . Net
      revenue includes sales of hardware and services (including extended service
      contracts and professional services). These products and services are sold
      either separately or as part of a multiple-element arrangement. Viking allocates
      revenue from multiple-element arrangements to the elements based on the relative
      fair value of each element, which is generally based on the relative sales
      price
      of each element when sold separately. The allocation of fair value for a
      multiple-element arrangement is based on vendor specific objective evidence
      (“VSOE”) or in absence of VSOE for delivered elements, the residual method. In
      the absence of VSOE for undelivered elements, revenue is deferred and
      subsequently recognized over the term of the arrangement. For sales of extended
      warranties with a separate contract price, Viking defers revenue equal to the
      separately stated price. Revenue associated with undelivered elements is
      deferred and recorded when delivery occurs.





Product
      revenue is recognized, when both title and risk of loss transfer to the
      customer, provided that no significant obligations remain. Revenue from extended
      warranty and service contracts, for which Viking is obligated to perform, is
      recorded as deferred revenue and subsequently recognized over the term of the
      contract or when the service is completed.





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 product has been shipped, the selling price is fixed or determinable, and
      collection is reasonably assured. Most 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 September 30,
      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. 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 are
      remeasured, and any changes in the fair value are recorded as a gain or loss
      on
      derivatives in the statement of operations.





19





**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.





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
      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.





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
(“ SFAS  No.
      157 ”). SFAS  No.
      157 defines
      fair value, establishes a framework for measuring fair value, and expands
      disclosures about fair value measurements. This Statement focuses on creating
      consistency and comparability in fair value measurements. SFAS  No.
      157 is
      effective for fiscal years beginning after November 15, 2007, and interim
      periods within those fiscal years.  We are currently evaluating the impact
      of adopting SFAS 157 on our financial statements.





20





**RESULTS
      OF OPERATIONS**





**Three
      Month and Nine Month Periods Ended September 30, 2006 Compared to the Three
      and
      Nine Month Periods Ended September 30, 2005**





***Sales.*** ** For
      the
      three months ended September 30, 2006, we had sales $1,514,591 compared to
      sales
      of $1,117,806 for the three months ended September 30, 2005. This represents
      a
      increase of $396,785 or 35%. Sales to individual customers exceeding 10% or
      more
      of revenues in the three months ended September 30, 2006 were to three customers
      who accounted for 25.5%, 14.5%, and 11.7% of revenues, respectively. For the
      nine months ended September 30, 2006, we had product sales of $3,652,615
      compared to product sales of $3,076,622 for the nine months ended September
      30,
      2005. This represents an increase of $575,993 or 19%. Sales to individual
      customers exceeding 10% or more of revenues in the nine months ended September
      30, 2006 were to three customers who accounted for 21.2%, 17.7%, and 13.4%
      of
      revenues, respectively.





***Gross
      Profit.*** We had
      gross profit of $502,037 or 33% of total revenues for the three months ended
      September 30, 2006 and gross profit of $319,870 or 29% of total revenues for
      the
      three months ended September 30, 2005, representing an increase of $182,167.
      The
      increase in gross profit during the third quarter of 2006 was due to increased
      sales compared to the prior quarter and to a mix of higher margin product
      revenues. We had gross profit of $1,007,361 or 28% of total revenues for the
      nine months ended September 30, 2006 and gross profit of $853,036 or 28% of
      total revenues for the nine months ended September 30, 2005, representing a
      increase of $154,325. The increase in gross profit during the nine months of
      2006 was due to increased sales and a mix of higher margin product
      revenues.





***Sales
      and Marketing Expenses*** **.** Selling
      and Marketing expenses were $1,311,849 for the three months ended September
      30,
      2006 and $734,915 for the three months ended September 30, 2005. For the nine
      months ended September 30, 2006 Selling and Marketing expenses were $3,321,458
      compared to $1,903,956 for the nine months ended September 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. During the three and nine
      months ended September 30, 2006, we recorded $215,064 in non-cash, stock based
      compensation expense in connection with a marketing consulting agreement.





***Research
      and Development Expenses.*** ** Research
      and Development expenses were $445,023 for the three months ended September
      30,
      2006 and $242,421 for the three months ended September 30, 2005. For the nine
      months ended September 30, 2006 Research and Development expenses were
      $1,069,283 compared to $669,701 for the nine months ended September 30, 2005.
      The year-over-year increase is due to the continued development of our 3Di
      product line as well as the development of OEM customer product lines for new
      customers. We expect that our research and development expenses will increase
      from current levels as we continue to develop, maintain and support our current
      products and introduce new products.





***General
      and Administrative Expenses.*** ** We had
      General and Administrative expenses of $706,777 for the three months ended
      September 30, 2006 and $418,928 for the three months ended September 30, 2005.
      For the nine months ended September 30, 2006 General and Administrative expenses
      were $1,920,401 compared to $1,248,172 for the nine months ended September
      30,
      2005. We expect that our General and Administrative expenses will increase
      from
      their current levels as we 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. During the nine months ended September 30, 2006 we recorded
      $325,165 in incremental stock-based compensation expense associated with the
      adoption of Statement No. 123(R).





***Other
      Income and Expenses.*** We
      had
      interest income of $31,147 for the three months ended September 2006 and
      interest income of $52,934 and a $4,975,824 gain on the extinguishment of debt
      for the nine months ended September 30, 2006. We had no such income in the
      comparable periods in 2005. Interest income in 2006 resulted from the proceeds
      of our May 2006 preferred stock financing being deposited in interest bearing
      accounts. In April 2006 the Company and note holders agreed to modify certain
      terms of convertible notes totaling $5,250,000. As a result, the Company
      recorded a $4,975,824 gain on debt extinguishment 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).





21





We
      had no
      non-cash amortization of debt discount expenses for the three months ended
      September 30, 2006 and amortization of debt discount expenses of $924,500 for
      the three months ended September 30, 2005. Amortization of debt discount
      expenses for the nine months ended September 30, 2006 totaled $8,480,878 and
      for
      the nine months ended September 30, 2005 were $1,678,623, representing an
      increase of $6,802,255. 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. We also adjusted
      the fair value of all the Company’s warrants with the recognition of a non-cash
      derivative liability gain of $3,549,839 for the three months ended September
      30,
      2006 and a non-cash derivative liability gain of $1,937,229 for the nine months
      ended September 30, 2006.





***Net
      Income (Loss).*** We had
      net income of $1,501,248 for the three months ended September 30, 2006 and
      a net
      loss of $2,080,043 for the three months ended September 30, 2005. During the
      quarter ended September 30, 2006 we recorded a gain on the derivative liability
      in the amount of $3,549,839, which more than offset our operating loss of
      $1,961,612. We had a net loss of $7,242,793 for the nine months ended September
      30, 2006 and a net loss of $4,820,374 for the nine months ended September 30,
      2005, representing a year-over-year increase in our net loss of $2,422,419
      for
      the nine months of 2006 compared to the nine months of 2005.We incurred
      significant costs operating our business, and implementing our sales and
      marketing plan,. During the nine months ended September 30, 2006 we also
      incurred $8,480,878 in non-cash interest expense related to the amortization
      of
      the debt discount on the Convertible Notes, partially offset by a $4,975,824
      gain on the extinguishment of debt and $1,937,229 in non-cash derivative
      gain.





**LIQUIDITY
      AND CAPITAL RESOURCES**





We
      have
      financed our operations principally through private sales of equity securities
      and convertible notes. From January 1, 2004 through September 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 September 30, 2006, we had cash, cash equivalents and
      short-term investments of $1,836,595 compared to $434,503 as of December 31,
      2005. We incurred operating losses in 2006 and 2005, and at September 30, 2006,
      had an accumulated deficit of approximately $17,086,933.





Net
      cash
      used in operating activities was $5,523,993 **** and
      $3,836,081 during the nine months ended September 30, 2006 and September 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.





Net
      cash
      used in investing activities was $322,446 and $358,520 during the nine months
      ended September 30, 2006 and 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 $7,248,531 and $4,216,471 during the nine
      months ended September 30, 2006 and September 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 and an increase
      of $184,673 in short-term bank borrowings. In 2005 we received $3,750,000 in
      proceeds from convertible notes payable, $100,000 from convertible notes payable
      to a related party and $366,471 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 originally expired in September 2006 and was extended
      to November 11, 2006 and currently subject to its annual renewal. As of
      September 30, 2006, we had outstanding borrowings under this credit facility
      in
      the amount of $395,873. 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.





22





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 fourth
      quarter of 2006. During the quarter ended September 30, 2006, 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. Through September 30, 2006, the cumulative accrued
      delay fee totaled $84,300.





***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.








**Forward
      Outlook and Risks**


Except
        as set forth below, during the quarter and nine months ended September 30,
        2006,
        there were no material changes to the quantitative and qualitative disclosures
        of our Risk Factors previously reported in the Annual Report contained in
        the
        Company's Form 10-KSB for the year ended December 31, 2005. See "Risk Factors"
        in the Company's in the Managements Discussion an Analysis Section of  Form
        10-KSB for the year ended December 31, 2005 for a detailed
        discussion.
 
 ***Issuance
        of Preferred Stock.*** In
        May 2006 we issued 8,000 shares of Series B Preferred Stock to investors
        in
        consideration for $7,250,000 in cash and $750,000 in debt conversion. The
        shares of Series B Preferred Stock are convertible into 44,444,444 shares
        of our
        common stock subject to certain adjustments (the “Conversion Shares”). We are
        required to pay dividends on these shares of preferred stock.  We also
        issued the Series B Preferred investors warrants to purchase 22,222,222 shares
        of our common stock (the “Warrant Shares”) at $.35 per share subject to certain
        adjustments. The other terms and conditions of the preferred stock are described
        in footnote 7 to the financial statements included in this form 10-QSB.
 
 We
        agreed to register for the Series B Preferred stockholders all 44,444,444
        Conversion Shares together with the 22,22,222 Warrant Shares so they could
        ultimately be resold in market or private transactions by the Series B Preferred
        investors in such amounts and at such times as they individually decide.
        If we
        fail to comply with all of our obligations in the preferred stock documentation,
        including dividend payments, registration of securities and other matters,
        it
        could allow the preferred stockholders to require us to redeem their shares
        of
        preferred stock for cash or by issuing shares of common stock at discount
        price.
 
 In
        August 2006, the Securities and Exchange Commission (“SEC”) declared effective
        our Registration Statement on form SB-2 covering 30,800,000 of the 44,444,444
        Conversion Shares. This was a resale registration statement under SEC Rule
        415(A) (1)(i). After such registration statement was declared effective we
        filed
        a second registration statement for the remaining Conversion Shares and all
        of
        the Warrant Shares. On November 8, 2006, we were notified by the SEC, that
        they
        would not allow the remaining Conversion Shares and the Warrants Shares to
        be
        registered on a resale basis under SEC Rule 415(A) (1)(i) and registration
        of
        such shares must be done as a primary registration. We disagree with the
        SEC’s
        position but have not yet decided what course of action we will take. We
        do not
        currently know what actions the Series B investors will take as a result
        of this
        recent development. We could suffer adverse consequences under the Series
        B
        Preferred Stock transaction documents including significant dilution resulting
        from the SEC’s position on our second registration statement.
 23
  ***Additional
        Financing Requirements.*** We completed the sale of shares of Series B Preferred Stock and converted
        approximately $5,500,000 of convertible promissory notes into shares of our
        common stock and Series B Preferred Stock in May, 2006. We anticipate that
        we
        will have adequate cash resources to fund our operations for approximately
        the
        next 2 months. We expect to raise additional funds through debt or the sale
        of
        additional equity securities to maintain sufficient operating capital.
        Thereafter, our liquidity and capital requirements will depend upon numerous
        other factors, including the following:
  ·
              The
                  extent to which our products and services gain market
                  acceptance;·
              The
                  progress and scope of product evaluations;·
              The
                  timing and costs of filing future regulatory
                  submissions;·
              The
                  timing and costs required to receive both domestic and international
                  governmental approvals;·
              The
                  timing and costs of acquisitions and product and services
                  introductions;·
              The
                  extent of our ongoing research and development
                  programs;·
              The
                  costs of sponsorship training of physicians to become proficient
                  in the
                  use of our products and procedures; and·
              The
                  costs of developing marketing and distribution
                  capabilities.
 
 If,
        in
        the future we are required to seek additional financing in order to fund
        our
        operations and carry out our business plan, 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.




**ITEM
      3.  CONTROLS AND PROCEDURES**


EVALUATION
      OF DISCLOSURE CONTROLS AND
      PROCEDURES




**(a)
        Evaluation of Disclosure Controls and Procedures**
  The
        Company, under the supervision and with the participation of its management,
        including its Chief Executive Officer (the principal executive officer) and
        Chief Financial Officer (the principal financial officer), evaluated the
        effectiveness of the design and operation of its disclosure controls and
        procedures as of the end of the period covered by this report. Based on that
        evaluation, and taking into consideration the material weaknesses identified
        in
        the letter from the Company's auditor as discussed below, the Chief Executive
        Officer and Chief Financial Officer concluded that, as of the end of the
        period
        covered by this report, the Company's disclosure controls and procedures
        were
        not effective for the purposes of recording, processing, summarizing and
        timely
        reporting of material information relating to the Company required to be
        included in its periodic reports. The Company's management received a letter
        dated March 31, 2006 (the "Letter") from Peterson & Co., LLP, our
        independent auditors, addressed to the Audit Committee of the Company's Board
        of
        Directors in connection with the audit of our financial statements as of
        December 31, 2005, which identified certain matters involving internal control
        and its operation that they consider to be significant deficiencies or material
        weaknesses under the standards of the Public Company Accounting Oversight
        Board.
        These material weaknesses were: (1) absence of appropriate segregation of
        duties
        consistent with control objectives; (2) insufficient personnel resources
        and
        technical accounting expertise within the accounting function to resolve
        non-routine or complex accounting matters; (3) ineffective controls over
        period
        end financial close and reporting processes; and (4) inadequate procedures
        for
        appropriately identifying, assessing and applying accounting principles.
  At
        the
        end of May, 2006, we hired a new Chief Financial Officer and in September,
        2006
        we hired a new controller and have begun to address the weaknesses identified
        in
        our independent auditor’s letter of March 31, 2006. We will continue to monitor
        and evaluate the effectiveness of our disclosure controls and procedures
        and our
        internal controls over financial reporting on an ongoing basis and are committed
        to taking further action and implementing additional enhancements or
        improvements, as necessary and as funds allow.
  **(b)
        Changes in Internal Controls Over Financial Reporting**
  Other
        than noted above, there have been no changes in our internal control over
        financial reporting identified in connection with the evaluation required
        by
        paragraph (d) of Rules 13a-15 or 15d-15 under the Exchange Act that occurred
        during our last fiscal quarter that has materially affected, or is reasonably
        likely to materially affect our internal control over financial
        reporting.


**PART
      II - OTHER INFORMATION**





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





Item
      2.  Unregistered
      Sales of Equity Securities .   
      Non-Applicable





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





Item
      4.  Submission
      of Matters to Vote of Security Holders .   
      None





Item
      5.  Other
      Information .







24





**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.








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.





25





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:
                November 15, 2006
            VIKING
                SYSTEMS, INC.By:/s/
                Donald
                TuckerDonald
                Tucker
              Chief
                Executive Officer, PresidentBy:/s/
                Gregory M.
                DeckerGregory
                  M. Decker
              Chief
                Financial Officer








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