UNITED
STATES SECURITIES
AND EXCHANGE COMMISSION Washington,
DC 20549
  **FORM 20-F**
  o
    REGISTRATION
      STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT
      OF 1934
 
 x
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
      SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended: December 31,
      2004
 
 o
    TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 Commission
file number: 000-24018
  ****
 ****
**Zi
      Corporation**(Exact name of Registrant as specified in its
      Charter)**Alberta,
      Canada**(Jurisdiction of incorporation or
      organization)**2100, 840 - 7thAvenue
      S.W., Calgary, Alberta T2P 3G2**(Address of principal executive
      offices)Securities registered or to be registered
      pursuant to Section 12(b) of the Act.**None**Securities registered or to be registered
      pursuant to Section 12(g) of the Act.**Common Shares, no par
      value**(Title of Class)Securities for which there is a reporting
      obligation pursuant to Section 15(d) of the Act.**None**Indicate the number of outstanding
      shares of each of the issuer’s classes of capital or common stock as of
      December 31, 2004.**45,225,190 Common Shares, no par
      value**
  Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
 
 
 x Yes
    o  No
   1
   Indicate by check mark which financial
      statement item the registrant has elected to follow.o Item 17
    x Item 18
 
  2
   **TABLE
OF CONTENTS**
 
  Page**PART
    I**
    **7****Introduction**
    **7****Forward
      Looking Information**
    **7****Item 1 - Identity
      of Directors, Senior Management and Advisers**
    **8****Item 2 - Offer
      Statistics and Expected Timetable**
    **8****Item 3 - Key
      Information**
    **8**A.
    Selected
      Financial Data
    8B.
    Capitalization
      and Indebtedness
    10C.
    Reasons
      for the Offer and Use of Proceeds
    10D.
    Risk
      Factors
    10**Item 4 -
      Information on the Company**
    **19**A.
    History
      and Development of the Company
    19B.
    Business
      Overview
    28C.
    Property,
      Plant and Equipment
    35**Item 5 -**
    **36**A.
    Operating
      Results
    36**Software
      Development Costs**
    **37****Revenue
      Recognition**
    **38****Stock-based
      Compensation Plan**
    **38**Operating
      Results
    39B.
    Liquidity
      and Capital Resources
    46C.
    Research
      and Development, Patents and Licenses, etc.
    49D.
    Trend
      Information
    51**Item 6 -
      Directors, Senior Management and Employees**
    **56**
 ****
 3
 ****
 
 A.
    Directors
      and Senior Management
    56Stock
      Options
    60Long-term
      Incentive Plans
    62Stock
      Appreciation Rights and Restricted Shares
    62Stock
      Option and SAR Repricing
    62Pension
      and Retirement Plans and Payments made upon Termination of
      Employment
    62Employment
      Contracts
    62B.
    Board
      Practices
    65C.
    Employees
    68D.
    Share
      Ownership
    69Purpose
      of Plans
    70Eligibility
    70Administration
      of the Plans
    71Amendment
      of the Plans
    71Necessary
      Approvals
    71Adjustment
      in Shares Subject to the Plan
    71**Item 7
      - Major Shareholders and Related Party
      Transactions**
    **73**A.
    Major
      Shareholders
    73B.
    Related
      Party Transactions
    74C.
    Interests
      of Experts and Counsel
    75**Item 8
      - Financial Information**
    75A.
    Consolidated
      Statements and Other Financial Information
    75B.
    Significant
      Changes
    78**Item 9 - The
      Offer and Listing**
    **78**A.
    Offer
      and Listing Details - Stock Price History
    78B.
    Plan
      of Distribution
 
 ****
 
 4
 
 
 C.
    Markets
    80D.
    Selling
      Shareholders
    80E.
    Dilution
    80F.
    Expenses
      of the Issue
    80**Item 10 -
      Additional Information**
    **80**A.
    Share
      Capital
    80B.
    Memorandum
      and Articles of Association
    80C.
    Material
      Contracts
    86D.
    Exchange
      Controls
    86E.
    Taxation
    87F.
    Dividends
      and Paying Agents
    91G.
    Statement
      by Experts
    91H.
    Documents
      on Display
    91I.
    Subsidiary
      Information
    92****
    ******Item 11 -
      Quantitative and Qualitative Disclosure About Market
      Risk**
    **92**A.
    Financial
      Instruments
    92B.
    Foreign
      Currency
    93**Item 12 -
      Description of Securities Other than Equity
      Securities**
    **93****Part II****Item 13 -
      Defaults, Dividend Arrearages and
      Delinquencies**
    **93****Item 14 -
      Material Modifications to the Rights of Security Holders and Use of
      Proceeds**
    **93****Item 15 -
      Controls and Procedures**
    **93****Item 16 -
      [Reserved]**
    **94****Item
      16A - Audit committee financial expert**
    ****94******Item
      16B - Code of Ethics**
    ****94******Item
      16C - Principal Accountant Fees and
Services**
    **95**
 
 
 5
 **Item
      16D - Exemption
      from the Listing Standards for Audit
      Committees**
    ****95******Item
      16E - Purchases
      of Equity Securities by the Issuer and Affiliated
      Purchasers**
    ******95********Part III**
    **95****Item 17 - Financial
      Statements**
    **95****Item 18 - Financial
      Statements**
    **96****Item 19 - Exhibits**
    **97****SIGNATURE**
    **97****CERTIFICATION**
    **98**
 
  6
 ****
 **PART
I**
  **Introduction**
  Zi
Corporation is a corporation incorporated under the laws of the province of
Alberta, Canada and is referred to in this document, together with its
subsidiaries, as “Zi” or the “Company”. Unless the context otherwise indicates,
use of “we”, “us”, “our” and like terms refers to the Company.
  Trademarks
or trade names of Zi used in this document include, but are not limited to:
Zi ® ,
eZiText ® ,
eZiNetTM, eZiTap TM , QixTM,
Decuma®, Zi ServicesTM, OztimeTM and EnglishPracticeTM. Each trademark, trade name
or service mark of any other company appearing in this document belongs to its
holder. Zi has obtained registered status on its “eZiText” trademark in the
United States, Canada, Australia and in parts of Asia and Europe and
registration is pending in China. The wordmark, “Zi”, is registered in Canada,
China, Japan, the United States, Singapore, Taiwan and Korea.
  The
Company’s consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America (“US
GAAP”) and are presented in United States dollars unless otherwise indicated.
All references in this Form 20-F to financial information concerning the Company
refer to such information in accordance with US GAAP and all dollar amounts in
this Form 20-F are in United States dollars unless otherwise indicated. Prior to
the preparation of the consolidated financial statements for the year ended
December 31, 2003, the consolidated financial statements of Zi Corporation were
prepared in accordance with Canadian GAAP with an annual reconciliation of the
Company’s financial position and results of operations as calculated using U.S.
GAAP. In order to provide information on a more comparable basis with its
industry peers and to better assist with the understanding of the financial
statements to the majority of users, who are in the United States, effective
December 31, 2003, the Company began reporting its financial position, results
of operation and cash flows under U.S. GAAP in its consolidated financial
statements. The effects on net loss arising from differences in generally
accepted accounting principles between the United States of America and Canada
are outlined in note 16 to the consolidated financial statements. Effective
March 31, 2004, the Company initiated reporting its consolidated financial
statements in US dollars, with comparative periods restated to US dollars. The
comparative amounts in this Form 20-F have been restated to US
dollars.
  On March
23, 2005, the exchange rate for the United States of America (“US”) dollar was
$0.8242 = CDN$1.00. Please see *Item 3 -
Key Information - Selected Financial Data* for more
detailed US dollar to Canadian dollar exchange rate information.
  In this
document, we may provide cross-references relevant to the information being
provided. These cross-references are provided for ease of reference only and are
not meant to be exclusionary to other relevant information in this document that
may relate to the disclosure in question.
  **Forward
Looking Information**
  This
Form 20-F annual report contains “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995. Shareholders
can identify these forward looking statements when they see us using words such
as “expect”, “anticipate”, “estimate”, “believe”, “may”, “potential”, “intends”,
“plans” and other similar expressions or statements that an action, event or
result “will”, “may”, “could” or “should” be taken, occur or be achieved, or the
negative thereof or other similar statements. These statements are only
predictions and involve known and unknown risks, uncertainties and other factors
which may cause our actual results, performance or achievements, or industry
results, to be materially different from any future results, performance, or
achievements expressed or implied by these forward-looking statements. These
factors include, among others, the following: our history of operating losses
and uncertainty of future profitability; the possible impact of future
financings; uncertainty as to the degree of and continuing market acceptance of
our products and services; uncertainties relating to product development; risks
associated with the number, amount and timing of new product introductions;
uncertainty regarding patents, proprietary rights and software piracy;
variability in customer demand; our dependence on third party performance under
marketing and licensing arrangements; risks associated with the contingent
nature of continued performance under major sales contracts; rapid technological
change and competition; uncertainty regarding the pricing and collection of
accounts; risks associated with dependence on sales in foreign countries; the
potential for adverse developments in pending litigation; risks associated with
the settlement of a US patent infringement lawsuit; fluctuations in foreign
exchange rates; uncertainties associated with changes in government policy and
regulation, particularly in the People’s Republic of China (“PRC” or “China”);
adverse changes in general business conditions in any of the countries in which
we do business; changes in our size and structure; the effectiveness of our
management and our strategic relationships, investment risks associated with our
e-Learning investments and other risks and uncertainties described under
“ *Item 3 -
Key Information - Risk Factors* ” and
elsewhere in this report.
 
 
 7
  
 Forward-looking
statements are based on the beliefs, opinions and expectations of our management
on the date the statements are made. Although we believe that the
forward-looking statements presented in this document are reasonable, we do not
guarantee that they accurately or completely predict, reflect or state future
results, levels of activity, performance, achievements or occurrence and we do
not assume responsibility for failure to do so. Except as required by law we do
not undertake to update forward-looking information to reflect actual results,
new information, occurrence of future events, or changes in management’s
beliefs, opinions or expectations. No undue reliance should be placed on such
forward-looking statements.
  **Item 1
-** **Identity
of Directors, Senior Management and Advisers**
  Not
applicable.
  **Item 2
-** **Offer
Statistics and Expected Timetable**
  Not
applicable.
  **Item 3
-** **Key
Information**
 
 *A.            
Selected Financial Data*
  The
following table summarizes certain of our selected financial information (stated
in thousands of US dollars) prepared in accordance with US GAAP. The information
in the table was derived from the more detailed financial statements for the
fiscal year ended December 31, 2000 through the fiscal year ended
December 31, 2004, inclusive, and the related notes, and should be read in
conjunction with the financial statements and with the information appearing
under the headings “ *Item 5 -
Operating and Financial Review and Prospects* ” and
“ *Item 18 -
Financial Statements* ”. The
consolidated statements of loss information for fiscal years 2000 and 2001, and
the consolidated balance sheet information as of December 31, 2000,
December 31, 2001 and December 31, 2002, as set forth below, have been derived
from audited Consolidated Financial Statements not included in this annual
report. Historical results are not necessarily indicative of results to be
expected for any future period. No dividends have been paid in any of the fiscal
years ended December 31, 2000 throughout the fiscal year ended December 31,
2004.
   8
   **2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(in
      thousands of US dollars except per share data)**Revenue
      from continuing operations
    
    
    13,403
    
    
    10,603
    
    
    8,416
    
    
    3,418
    
    
    4,419Operating
      loss from continuing operations (1)
    
    
    (2,460
    )
    
    (2,336
    )
    
    (19,246
    )
    
    (8,934
    )
    
    (6,227
    )Operating
      loss from continuing operations per share
    
    
    (0.06
    )
    
    (0.08
    )
    
    (0.52
    )
    
    (0.24
    )
    
    (0.17
    )Net
      loss from continuing operations (1)
    
    
    (2,388
    )
    
    (2,931
    )
    
    (19,498
    )
    
    (8,081
    )
    
    (4,013
    )Net
      loss from continuing operations per share
    
    
    (0.06
    )
    
    (0.08
    )
    
    (0.52
    )
    
    (0.22
    )
    
    (0.11
    )Net
      loss (2)
    
    
    (2,388
    )
    
    (2,931
    )
    
    (25,206
    )
    
    (13,224
    )
    
    (8,512
    )Net
      loss and diluted net loss per share
    
    
    (0.06
    )
    
    (0.08
    )
    
    (0.67
    )
    
    (0.36
    )
    
    (0.23
    )Total
      assets
    
    
    21,699
    
    
    10,686
    
    
    11,870
    
    
    30,167
    
    
    41,772Capital
      stock
    
    
    108,139
    
    
    94,559
    
    
    91,165
    
    
    89,966
    
    
    88,099Accumulated
      deficit and other comprehensive
      income
    
    
    (92,391
    )
    
    (90,278
    )
    
    (87,510
    )
    
    (62,462
    )
    
    (48,490
    )Net
      assets
    
    
    15,749
    
    
    4,281
    
    
    3,655
    
    
    27,504
    
    
    39,609Outstanding
      shares, in thousands
    
    
    45,225
    
    
    39,372
    
    
    37,914
    
    
    37,544
    
    
    36,991
 (1) 2002
operating and net loss from continuing operations includes litigation and
judgement costs of $7.1 million and impairment of intangible assets of $2.9
million. 2004 operating and net loss from continuing operations includes a $2.0
million impairment charge relating to a note receivable.
  (2) 2002
net loss includes loss from discontinued operations of $5.7 million (2001 - $5.1
million; 2000 - $4.5 million)
  *Currency
and Exchange Rates*
  The
following table sets out the exchange rates for US dollars expressed in terms of
one Canadian dollar in effect at the end of the following periods, and the
average exchange rates (based on the average of the exchange rates on the last
day of each month in such periods):
  **US
      Dollars Per One Canadian Dollar**
      **Year
      Ended December 31****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000**End
      of period
    
    
    0.8319
    
    
    0.7713
    
    
    0.6339
    
    
    0.6275
    
    
    0.6666Average
      for the period
    
    
    0.7685
    
    
    0.7158
    
    
    0.6369
    
    
    0.6461
    
    
    0.6740
 The
following table sets out the high and low exchange rates for US dollars
expressed in terms of one Canadian dollar in effect at the end of the following
periods:
  **US
      Dollars per One Canadian Dollar****September**
      **2004**
    
    **October**
      **2004**
    
    **November**
      **2004**
    
    **December**
      **2004**
    
    **January**
      **2005**
    
    **February**
      **2005**High
      for the month
    
    
    0.7855
    
    
    0.8201
    
    
    0.8493
    
    
    0.8435
    
    
    0.8346
    
    
    0.8134Low
      for the month
    
    
    0.7651
    
    
    0.7858
    
    
    0.8155
    
    
    0.8064
    
    
    0.8050
    
    
    0.7961
   9
 
 Exchange
rates are based upon the noon buying rate in New York City for cable transfers
in foreign currencies, as certified for customs purposes by the Federal Reserve
Bank of New York. The noon rate of exchange on March 23, 2005 as reported by the
United States Federal Reserve Bank of New York for the conversion of United
States dollar into Canadian dollars was US$1.00 = CDN$1.2133.
  ***B.*** ***Capitalization
and Indebtedness***
  Not
applicable.
  ***C.*** ***Reasons
for the Offer and Use of Proceeds***
  Not
applicable.
  ***D.******Risk
Factors*********
  We
operate in a dynamic and rapidly changing environment that involves numerous
risks and uncertainties, many of which are beyond our control. Shareholders
should carefully consider the risks described below before purchasing our
Company’s common shares. The occurrence of any of the following events could
harm us. If these events occur, the trading price of our Company’s common shares
could decline, and shareholders may lose all or part of their investment.
  ***We
have incurred net losses to date and may not become
profitable.***
  Our
Company has a limited history of operating profits. Our consolidated net losses
totalled $2.4 million in our fiscal year ended December 31, 2004, $2.9 million
in our fiscal year ended December 31, 2003, and $25.2 million in our fiscal year
ended December 31, 2002. As of December 31, 2004, our accumulated deficit was
$91.9 million. While we have recently been able to generate quarterly operating
profits, net losses may continue. We face significant and potentially costly
challenges in simultaneously pursuing key research and development goals and
attracting customers for our products and services.
  ***Our
shareholders may face dilution in future financings and our business may be
restricted by future borrowings.***
  Additional
future financings may involve the issuance of additional common shares or other
equity and/or debt securities and other forms of borrowing. Issuances of
additional equity securities may dilute the per share value of common shares
held by our existing shareholders. If we issue debt securities or obtain other
forms of borrowings, we may have to accept terms or borrowing arrangements that
limit our ability to incur additional debt, require us to maintain certain
financial ratios or subject us to other covenants that could restrict our
business and growth.
  ***The
price of our common shares and our ability to access capital markets may be
affected by Lancer’s ownership of our common shares.***
  In August
2003 we became aware of information that suggested a group of funds, including
Lancer Partners LP and Lancer Offshore Inc. (collectively, the “Lancer Funds”),
had accumulated a significant percentage of our outstanding common shares. This
information followed the appointment in July 2003 of a receiver for the Lancer
Funds who was appointed as a result of an SEC enforcement proceeding which
alleged securities law violations by the management of the Lancer Funds. In
December 2003, we learned through Lancer Funds’ regulatory disclosure that the
Lancer Funds’ ownership amounted to approximately 49% of our outstanding shares.
While the enforcement proceeding did not allege wrongdoing in connection with
our common shares or any of the affairs of the company, the accumulation was
done in apparent violation of U.S. and Canadian securities laws, and without our
knowledge or assistance. We believe we may be adversely affected in the
following ways:
   10
   §
    the
      price of our common shares may have been affected by periodic news reports
      relating to the legal proceedings affecting the Lancer
    Funds;
 §
    Certain
      investors have been reluctant to invest in our securities due to
      uncertainties regarding potential market or other sales or distributions
      of Zi common shares by the receiver for the Lancer
  Funds;
 §
    The
      Company’s ability to raise capital has and may continue to require the
      cooperation of the Lancer Funds through lock up agreements or other
      similar requirements.
 
 There can
be no assurance that our share price or our access to the capital markets will
not continue to be affected by the Lancer Fund’s ownership of our common
shares.
  ***We
operate in a new and developing market and we may not be able to sustain the
rapid development required in our industry to remain
competitive.***
  The
development of our input technology market depends upon:
  §
    the
      growth of third party applications incorporating our products and
      technologies;
 §
    the
      demand for new applications;
 §
    the
      ability of our products and technologies to meet and adapt to these needs;
      and
 §
    continuing
      price and performance improvements in hardware and software technology to
      reduce the cost and increase the performance of products incorporating our
      products and technologies.
 
 These
markets may not develop further and the current level of market acceptance of
our products may decrease or may not be sustainable. We must adapt to rapid
changes in technology and customer requirements to remain
competitive.
  The
market for our products has been characterized by:
  §
    rapid
      technological change;
 §
    frequent
      product introductions; and
 §
    evolving
      customer requirements.
 
 We
believe that these trends will continue into the foreseeable future. Our success
will depend, in part, upon our ability to:
  §
    enhance
      our existing products;
 §
    successfully
      develop new products or additional localized versions that meet
      increasingly demanding customer requirements;
and
 §
    gain
      market acceptance.
 
 To
achieve these goals, we will need to continue to make substantial investments in
product development and marketing. We may not:
  §
    have
      sufficient resources to make these
investments;
 §
    be
      successful in developing product enhancements or new products on a timely
      basis, if at all; or
 §
    be
      able to successfully market these enhancements and new products once
      developed.
 
  11
  
 Further,
our products may be rendered obsolete or uncompetitive by new industry
standards, changing technology or developments by competitors.
  If the
market for our products does not develop on a continuing and sustainable basis,
our financial position may be adversely impacted and could include recording
additional impairment charges on the value of capitalized software development
costs.
  ***We
operate in an intensely competitive environment and there can be no assurance
that we can compete successfully or gain market
acceptance.***
  The
software industry is intensely competitive and is characterized by rapid
technological advances, evolving industry standards and technological
obsolescence. Other corporations with greater financial and technical resources
and larger marketing organizations could enter the market and pose a potential
threat if they can develop technologies and products that can rival those
developed by us or under license to us. We understand that major Asian and North
American software and technology companies engage in development of input or
other interface software. Our actual or potential input technology competitors
include, but are not limited to: Motorola; AOL Time Warner (“AOL”); Nokia;
OpenWave; Apple; Microsoft; Research in Motion, Digit Wireless (Fastap),
Scansoft, CIC, PenReader, Vision Objects, TealPoint in Latin languages, PenPower
and HanWang. Many of our competitors have longer operating histories and have
greater financial, technical, sales, marketing and other resources. To a great
extent, our ability to compete will depend on such factors as product features,
technical superiority, ease of use, price, quality, technical support and
services, product development capabilities, marketing, distribution channels,
and ability to meet delivery schedules. There can be no assurance that our
products and services can compete successfully or gain market
acceptance.
  ***Our
products may contain defects that could harm our reputation, be costly to
correct, expose us to litigation and harm our operating results and profits.***
  We
develop software products that may contain undetected errors or failures. Design
errors or hidden defects in third party components or software may be discovered
after initial product sampling, resulting in delays in volume production or
recalls of products sold. If defects are discovered, we may not be able to
correct them in a timely manner or at all. Defects and failures in our products
could result in a loss of, or a delay in, market acceptance of our products. In
addition, defects in our products could cause adverse publicity, damage our
reputation and impair our ability to acquire new customers. In addition, we may
need to make significant expenditures to eliminate defects from our products.
  ***We
may be unable to develop and to maintain collaborative development and marketing
relationships, which could result in a decline in revenues or slower than
anticipated growth rates.***
  A key
element of our business strategy is the formation of collaborative relationships
with other leading companies. We believe that success will depend, in part, on
our ability to maintain these relationships and to cultivate additional
corporate alliances with such companies. There is no assurance that our
historical collaborative relationships will be commercially successful, that we
will be able to negotiate additional collaborative relationships, that such
additional collaborative relationships will be available to us on acceptable
terms, or that any such relationships, if established, will be commercially
successful. In addition, there is no assurance that parties with whom we have
established, or will establish, collaborative relationships will not, either
directly or in collaboration with others, pursue alternative technologies or
develop alternative products in addition to, or instead of, our products or
experience financial or other difficulties that lessen their value to us and to
our customers. Our financial condition or results of operations may be adversely
affected by either our failure or the failure of these third parties to
establish and maintain collaborative relationships.
   12
  ******
 ***We
rely on large and small OEM customers to adopt our technology and our financial
success may be affected if these OEMs either do not implement our technology or
suffer their own financial hardships.***
  Our
royalty and licensing fee-based revenues depend in substantial part on our
ability to successfully integrate and maintain compatibility of our technology
with the applications of our original equipment manufacturer (“OEM”) customers.
Because the Zi Technology business relies heavily on third party integration of
our technology into OEM customer products, lead time to revenue recognition is
longer than software products directly released into consumer channels. Purchase
of our products by OEM customers often requires significant expenditure of time
and resources by the OEMs. Accordingly, the decision to purchase our products
typically requires significant pre-purchase evaluation. We may spend significant
time educating and providing information to prospective customers regarding the
use and benefits of our products and technologies. During this evaluation
period, we may expend substantial sales, marketing and management
resources.
  Furthermore,
our products and technologies sold and integrated into customer applications are
subject to both customer production schedules and customer success in marketing
the products and generating product sales. Our revenues are thus subject to
delays and possible cancellation resulting from customer integration risks and
delays. We may not be successful in continuing to be selected as the language
enabling technology for these OEMs, and the failure to be selected by our OEM
customers would have a material adverse effect on our sales. In addition, the
resolution of a patent infringement claim restricts the Company and its
affiliates from using and selling certain no-longer distributed earlier versions
of eZiText for Latin-based languages in the United States. Furthermore, due to
our royalty-based revenue model, the failure of our key OEMs to achieve market
acceptance of products incorporating our software could have a material adverse
effect on our business, operating results and financial condition.
  Due to
these factors, our sales cycles are long and unpredictable. As a result, our
revenues may fluctuate from quarter to quarter and we may be unable to adjust
our expenses accordingly. This would cause our operating results and stock price
to fluctuate. OEMs and service providers typically perform numerous tests
and extensively evaluate products before incorporating them into products. In
addition, we expect that the delays which are inherent in our sales cycle could
raise additional risks of service providers deciding to cancel or change their
product plans. Our business would be adversely affected if a significant
customer reduces or delays orders during our sales cycle or chooses not to
deploy products incorporating our technology.
  Some of
our major direct customers are not profitable and are subject to reduced demand
for products and services currently affecting the telecommunications industry.
In 2004, 2003 and 2002 we derived 34, 26 and 25 percent respectively, of our
total revenue from two customers. We believe that revenue derived from current
and future customers who dominate handset phone manufacturing will continue to
represent a significant portion of our total revenue for our technologies. Our
inability to continue to secure and maintain a sufficient number of contracts
from such dominant OEM players would have a material adverse effect on our
business, financial condition, operating results and cash flows derived from our
technologies. Moreover, our success will depend in part upon our ability to
obtain orders from new customers, as well as the financial condition and success
of our customers and general economic conditions. Moreover, certain of our key
OEM licenses are at the end of their license terms and it is uncertain whether
we will be successful in negotiating renewals with these customers.
   13
  
 Our
overall market breadth for language input products and services may be
constrained by:
  ·
    the
      increasing market share of major handset industry
  leaders;
 ·
    the
      influence of software integrators and platform suppliers in serving new
      OEMs with pre-packaged solutions; and
 ·
    consolidation
      among the OEM customer base.
 
 ***Our
ability to operate could be hindered by the proprietary rights of others and our
inability to adequately protect our intellectual property rights***
  A number
of companies have developed technologies, filed patent applications or received
patents on various technologies that may be related to our business. Some of
these technologies, applications or patents may conflict with our technologies
or intellectual property rights. Such conflicts could limit the scope of the
patents, if any, that we may be able to obtain or result in the denial of our
patent applications altogether.
  If
patents that cover our activities are issued to other persons or companies, we
could be charged with infringement, and, as described in the section below, we
have been affected by such litigation. In the event that other parties' patents
cover any portion of our activities, we may be forced to develop alternatives or
negotiate a license for such technology. We may not be successful in either
developing alternative technologies or acquiring licenses upon reasonable terms,
if at all. Any such license could require the expenditure of substantial time
and other resources and could harm our business and decrease our earnings. If we
do not obtain such licenses, we could encounter delays in the introduction of
our products or could find that the development, manufacture or sale of products
requiring such licenses is prohibited.
  Existing
copyright, trademark, patent and trade secret laws only afford limited
protection for our proprietary rights. Third parties may attempt to copy or
reverse engineer aspects of our products or proprietary information.
Accordingly, we may not be able to adequately protect our intellectual property.
  ***Our
business may be adversely affected by a settlement agreement with our principal
competitor.***
  As
described in *Item 4 -
Information on the Company - Intellectual Property
Litigation* , the
Company and America Online Inc. (“AOL”) settled a judgment under a U.S. based
litigation by a written settlement agreement dated December 6, 2002. Under
the settlement agreement, the Company consented to, *inter
alia* , an
injunction under the Consent Judgement which prohibits the sale or use in the
United States of earlier versions of the Company’s eZiText product which are not
currently sold or offered for sale or used by the Company in the United States.
This injunction does not apply to or prohibit the sale or use of such earlier
versions of the Company’s eZiText product in countries other than the United
States. In the ordinary course of business, the Company, Tegic and others seek
to protect their intellectual property in various countries and jurisdictions
through administrative proceedings and civil litigation. The settlement of the
Tegic lawsuit dealt only with certain patent infringement claims in the United
States. There can be no assurance that we will be successful in various
challenges we have filed in respect of certain of Tegic’s patent claims outside
of the United States. The outcome of any of these proceedings, if determined
adversely, raises the possibility that additional civil action could follow.
   14
   ***We
need to be able to manage our growth or else our operating results and financial
condition will be materially adversely affected.***
  We
believe that continued growth in the number, breadth and complexity of our
product lines while controlling our operating costs will be required to
establish and maintain our competitive position. Our growth, coupled with the
rapid evolution of our markets, has placed, and is likely to continue to place,
significant strains on our administrative, operational and financial resources
and increased demands on its internal systems and procedures, particularly as
this growth has been, and will likely continue, on a global basis. In the event
that our operations continue to grow, or grow rapidly, there is a risk that our
current administrative infrastructure, systems and procedures may not be
adequate to support our operations, or that management may not be able to
achieve the rapid, effective execution of the product and business initiatives
necessary to successfully penetrate the markets for our products and services.
If we are unable to manage future growth effectively, our business, operating
results and financial condition may be materially adversely
affected.
  ***If
the Company does not continue to develop new products, future revenues will be
negatively affected.***
  The
Company’s existing product portfolio is limited. Our financial success relies
substantially on this limited number of products. Failure to innovate, develop
and integrate new products into our existing product lines, in addition to
enhancing the performance and functionality of existing products, could result
in the Company failing to achieve financial success.
  ***We
depend on our key personnel and failure to attract and retain these people could
have a negative impact on our operations*** ***.***
  Our
success will be dependent, in part, on the performance of our personnel who
develop our technology and manage our business. We have personnel that we
believe are competent in the development of our technology, services and
software related products and have endeavoured to hire and retain qualified
managerial and technology development services people for the development and
expansion of the Zi Technology business. Nevertheless, failure to retain their
expertise or to attract and retain key personnel with necessary technological
and marketing skills, in addition to Mike Donnell, President and Chief Executive
Officer, Milos Djokovic, Chief Operating Officer and Chief Technical Officer,
Glen Morgan, Senior Vice President Global Sales & Marketing and Dale Kearns,
Chief Financial Officer, could have a materially adverse effect upon our ability
to grow and operate profitably.
  ***We
operate in diverse geographic markets and face regulatory and political risks
abroad which could negatively impact our operations.***
  Our
products and technologies are sold in a number of countries throughout the
world. The primary markets for our products and technologies are Asia, North
America and Europe. Our international business operations expose us to
difficulties in coordinating our international activities and dealing with
multiple regulatory environments, as well as to risks of international political
and economic conditions.
   15
  Our
global business may be materially adversely affected by:
  §
    political
      and economic changes and disruptions in the countries into which we sell
      products or have operations;
 §
    limits
      on repatriation of earnings;
 §
    changes
      in various regulatory requirements and the cost of compliance with a wide
      variety of laws;
 §
    difficulties
      in enforcing contracts;
 §
    difficulties
      in protecting intellectual property
 §
    governmental
      currency controls;
 §
    export/import
      controls;
 §
    tariff
      regulations and other trade barriers;
 §
    costs
      and risks of localizing products for foreign
countries;
 §
    difficulties
      in staffing and managing operations in multiple locations in many
      countries;
 §
    greater
      difficulties in trade accounts receivable collection;
or
 §
    possible
      adverse tax consequences.
 
 In
addition, our operations and the market price of our common stock may also be
affected by adverse economic conditions in Asia, North America and Europe. Our
operations and our ability to continue to generate significant revenues in these
regions may be affected by adverse economic conditions or political instability
in such regions as well as other external business risks.
  There can
be no assurance that such factors will not materially adversely affect the
revenues from our international business and, consequently, our results of
operations. In addition, revenues and/or earnings earned abroad may be subject
to taxation by more than one jurisdiction, or certain expenses which we have
claimed as a deduction for tax may be disallowed for various reasons by a
domestic or foreign jurisdiction, which could materially adversely affect our
earnings.
  ***We
may need additional capital to support our operations and future
growth.***
  We may
require capital to finance the continued growth of operations. To date, we have
financed the majority of our growth largely through private placements of common
shares. As of February 28, 2005, our cash position was approximately $15.3
million. Unless our cash flow from operations is sufficient to meet our
operating capital requirements, any shortfall must be covered by our cash
position, the sale of securities or through other forms of third party
financing. We believe our current cash resources will be adequate to support our
existing business activities assuming stable revenue and absent unexpected costs
or expenses. See *Item 5 -
Operating and Financial Review and Prospects - Liquidity and Capital
Resources* .
However, we may still require additional financing to support our product
expansion or continued operations. There can be no assurance that sufficient
financing will continue to be available to sustain our operations and growth, to
develop new and existing markets or to complete development of products that
fully exploit our owned or licensed technologies. Failure to obtain adequate
additional financing on a timely basis could have a material adverse effect on
our business.
  ***Our
quarterly results are subject to fluctuations which could negatively affect our
financial results.***
 **
 **
 16
  We have
experienced, and are likely to continue to experience, significant fluctuations
in quarterly operating results caused by many factors. These factors
include:
  §
    dependence
      on the market acceptance and sales of our licensees’ products in which our
      technologies are embedded;
 §
    seasonality
      of sales of our licensees’ products;
 §
    changes
      in the demand for our technology;
 §
    the
      introduction or enhancement of products and services by us and our
      competitors and market acceptance of those enhancements or
      products;
 §
    delays
      in the introduction of products or enhancements by us or our
      competitors;
 §
    the
      timing of significant orders, delivery and implementation of our
      products;
 §
    the
      gain or loss of any significant customer;
 §
    changes
      in our pricing policies or those of our
competitors;
 §
    the
      mix of distribution channels through which products are sold and the mix
      of products and services sold;
 §
    the
      mix of international and North American
revenues;
 §
    exchange
      rate fluctuations;
 §
    the
      timing of any acquisitions and related
costs;
 §
    foreign
      currency exchange rates and general economic conditions;
    and
 §
    legal
      and other costs associated with defence and resolution of patent
      infringement claims.
 
 In
addition, there are several factors that could cause material fluctuations in
our revenues from quarter to quarter, including:
  §
    the
      size and timing of individual license transactions by our
      customers;
 §
    the
      potential for delay or deferral of customer implementation of our
      technology;
 §
    the
      terms of future licensing arrangements between us and our
      customers;
 §
    inaccuracies
      in reporting of royalties and license fees by
customers;
 §
    geopolitical
      events;
 §
    world
      health factors; and
 §
    credit
      risks such as bankruptcies or other economic hardships affecting any of
      our customers.
 
 In
addition, our new license revenue and results of operations may fluctuate on a
quarterly and annual basis in the future as a result of a number of factors,
many of which are outside of our control. A sale of a new license generally
requires a customer to make a purchase decision that involves a significant
commitment of capital. As a result, the sales cycle associated with the new
license revenue will vary substantially and will be subject to a number of
factors, including customers’ budgetary constraints, timing of budget cycles and
concerns about the pricing or introduction of new produces by us or our
competitors. If our revenues or operating results fall below the expectations of
financial analysts of investors, the trading price of our common shares could
fall.
  ***The
laws and policies restricting foreign alliances, partnerships, investments,
distribution or sale in the language and education software technology industry
could change and adversely affect our operations in these
countries.***
  We may
also be materially adversely affected by laws restricting foreign alliances,
partnerships and investment in the technology and information industries. Some
countries have extensive restrictions on foreign alliances, partnerships and
investments in the information industries. For example, China has substantial
limitations on companies that provide content on the Internet and dissemination
of information on the Internet. Internet service providers are governed under
telecommunications laws which substantially restrict foreign ownership and
investment in telecommunications companies in China. In 1999, the Chinese
government requested the termination of certain Chinese-foreign corporations on
the basis that the structure used for these corporations was no longer
permitted. There is no way of predicting whether the governments in the
countries in which we operate will enact any similar limitations with respect to
Oztime or any of the products or services that we sell or license, or whether
any such law, if enacted, will force us to reduce or restructure our products
and offerings in such countries. The realization of any of these possibilities
may substantially increase our costs of doing business or delay the
commercialization of our products, which may adversely affect our business and
results of operations.
   17
  We may be
materially adversely affected by foreign laws restricting the repatriation of
earnings. For example, the distribution of earnings from China to foreign
countries is subject to the approval of the Chinese Central Bank. The procedures
are complicated and time consuming. We may become subject to claims from third
parties (including foreign government agencies) based in foreign jurisdictions
for violations of their laws. These laws may be changed or new laws may be
enacted in the future. The administration and enforcement of law and justice in
some jurisdictions that we do business in may be different and therefore
unpredictable relative to US practice. International litigation is often
expensive, distracting and time consuming. These consequences could be
particularly disruptive to us given our relatively small size of operations and
limited resources. Accordingly, any occurrence of the foregoing could have a
material adverse effect on our business.
  ***We
are subject to foreign currency exchange risks, accordingly, fluctuations in
exchange rates could have a material effect on our results of
operations.***
  A
significant portion of our expenses have been, and will likely continue to be,
incurred or generated in currencies other than the U.S. dollars, principally the
Canadian dollar, Hong Kong dollar, Chinese renminbi and Swedish kormas. Our
results are reported in U.S. dollars. Accordingly, fluctuations in exchange
rates have a material effect on our results of operations. To date, we have not
engaged in foreign currency exchange rate hedging activities. If we implement
hedging techniques in the future with respect to foreign currency transactions,
there can be no assurance that we will be successful in such hedging activities.
Conversion of the Chinese renminbi to other currencies is subject to approval by
the government of China. Foreign exchange gains or losses for the past three
years have been: a gain of $275,834, a gain of $162,453, and a gain of $158,641
in each of 2004, 2003 and 2002, respectively.
  ***Acquisitions
of companies or technologies may result in disruptions to our business***
  As part
of our business strategy, we may acquire assets and businesses principally
relating or complementary to our current operations. Any acquisitions or mergers
by us will be accompanied by the risks commonly encountered in acquisitions of
companies. These risks include, among other things:
  §
    exposure
      to unknown liabilities of acquired companies;
 §
    higher
      than anticipated acquisition costs and expenses;
 §
    effects
      of costs and expenses of acquiring and integrating new businesses on our
      operating results and financial condition;
 §
    the
      difficulty and expense of integrating the operations and personnel of the
      target companies, especially where the target corporation is in a
      geographically distant location;
 §
    disruption
      of our ongoing business;
 §
    diversion
      of management's time and attention;
 §
    failure
      to enhance our financial and strategic position by the unsuccessful
      incorporation of acquired technology;
 §
    the
      inability to implement uniform standards, controls, procedures and
      policies;
 §
    loss
      of key employees and customers as a result of changes in management;
 §
    the
      incurrence of amortization expenses; and
 §
    possible
      dilution to our shareholders.
   18
 
 We may
not be successful in overcoming these risks or any other problems encountered in
connection with any acquisitions.
  Further,
the per share value of common shares held by our existing shareholders may be
diluted if equity securities are issued by us in connection with any
acquisition. If acquisitions are made for cash consideration, we may be required
to use a substantial portion of our available cash and cash equivalents.
Acquisition financing may not be available on acceptable terms, if at
all.
  ***We
may not be able to realize value from our investments in Oztime and Magic
Lantern Group.***
  We have
material investments in two e-Learning businesses, our wholly-owned subsidiary,
Oztime, and Magic Lantern Group, Inc., the latter of which is an AMEX-listed
company of which we own approximately 43% of its outstanding shares. During 2003
we determined to concentrate on our core Zi Technology business unit. As part of
this strategy, we regularly consider the monetization of the e-Learning
investments, consistent with maximization of value to the Company and our
shareholders. Market and industry conditions may limit our ability to achieve
these goals. We have written off the carrying value of these investments but we
have invested significant sums and would like to realize the value from such
investments. As a result, we may invest additional resources in order to
preserve their value. There can be no assurance that we will be able to realize
value from our affiliates.
  ***As
a non-US corporation, it may be difficult for shareholders to pursue claims
under US securities laws against us.***
  The
enforcement by investors of civil liabilities under the federal securities laws
of the United States may be affected adversely by the fact that we are
incorporated under the laws of Alberta, Canada, that the independent registered
chartered accountants who have audited our financial statements and some or all
of our directors and officers may be residents of Canada or elsewhere, and that
all or a substantial portion of our assets and said persons are located outside
the United States. As a result, it may be difficult for holders of the common
shares to effect service of process within the United States upon people who are
not residents of the United States or to realize in the United States upon
judgements of courts of the United States predicated upon civil liabilities
under the federal securities laws of the United States.
  **Item 4**-**** **Information
on the Company**
  ***A.*** ***History
and Development of the Company***
  Our head
and principal office is located at Suite 2100, 840 - 7 th Avenue
S.W., Calgary, Alberta, Canada T2P 3G2, our telephone number is
(403) 233-8875 and our facsimile number is (403) 233-8878. Our common
shares are listed on the Toronto Stock Exchange under the symbol “ZIC” and on
the NASDAQ National Market under the symbol “ZICA”.
   19
  
 We were
incorporated under the *Business
Corporations Act* (Alberta) in Alberta, Canada on December 4, 1987 as Cancom Ventures Inc. In
June, 1990, we changed our name to Multi-Corp Inc. and thereafter changed our
name to Zi Corporation in June, 1997.
  From 1993
to 1997, we were active in pursuing opportunities in the telecommunications
industry, purchasing and ultimately disposing of several privately held
companies involved in the telecommunications business. In one of these
acquisitions, we acquired all of the shares in the capital of Miami
International Gateway, Inc. (“MIG”), a US-based company engaged in the
telecommunications business. The MIG acquisition cost was $1,286,000, of which
$245,818 was paid in cash and 350,000 common shares at a deemed price of
CDN$3.95 per share. In March, 1997, we sold all of the shares in MIG to Custom
Technology Communication, a private Florida based company. From 1994 to 1998, we
provided limited translation services from our office in Hong Kong for
Chinese-to-English and English-to-Chinese using the translation capability of
the Chappell/Yates Translation Technology described below. We discontinued
translation services in 1998.
  During
1996 and 1997, we offered consulting services to companies in North America
seeking to use the Internet to market their products and services. This Internet
consulting service ceased operations in 1997.
  From
March 1997 to February 1998, we also provided Internet web development services
in conjunction with carrying on our present business.
  ***Acquisition
of Input Technology***
  Effective
November, 1993, we acquired three licenses relating to certain computer
software, word processing software and language translation technology known
respectively, as the “Jiejing Input System”, the “Zitong Input System” and the
“Chappell/Yates Translation Technology” (collectively, referred to as the
“Jiejing Licenses”).
  In
consideration for the Jiejing Licenses, we issued 5,000,000 common shares
to the vendors, all of which were placed in escrow pursuant to a performance
escrow agreement. The escrow agreement stipulated, among other things, that the
common shares would be earned out on the basis of one common share for each
CDN$0.10 of net cash flow in excess of CDN$500,000 whenever earned. In addition
to the 5,000,000 common shares, we paid acquisition fees of $400,000 to the
owners of the Jiejing Licenses.
  Effective
February, 1998, we acquired the rights to, and ownership, of the technology
underlying the Jiejing Licenses and terminated the Jiejing
Licenses.
  Consideration
given by us for acquiring the technology underlying the Jiejing Licenses was the
accelerated release of 4,525,000 of our common shares, previously issued and
held in escrow. In return for the accelerated release of these common shares
from escrow, the vendors of the technology:
  §
    assigned
      all rights to and ownership of such technology, subject to the exclusion
      outlined below;
 §
    agreed
      to the cancellation of 475,000 common shares previously issued and
      outstanding under the escrow terms and
conditions;
 §
    forgave
      outstanding license fees due and payable at December 31, 1997;
      and
 §
    terminated
      the Jiejing Licenses.
 
 20
 
 The
acquisition of the rights to the Jiejing Licenses was subject to one exclusion
which permitted the use of the “Jiejing Input System” in a proprietary language
teaching method used only to teach Mandarin Chinese. Winbo Mark Limited and
Chlorine Investments Limited (doing business as Mach Mandarin Limited in Hong
Kong), have an exclusive worldwide license to use the “Jiejing Input System”
technology in a specific proprietary language teaching software product. Under
the terms of the license, this software cannot be commercially sold, but may
only be used for face-to-face personal classroom teaching specifically for the
Mandarin Chinese dialect to non-Chinese speaking persons. These companies also
have a non-exclusive license to use certain components of the “Jiejing Input
System” technology and word processor components.
  On
December 17, 1997, we acquired full ownership rights to United States
patent number 5,109,352 (the “352 Patent” or the “O’Dell Patent”) which is
entitled “System For Encoding A Collection Of Ideographic Characters”. The 352
Patent can be generally described as a computer input system for Chinese and
Japanese characters where the different strokes for composing the characters are
classified into different groups, each identified by a code number. The string
of code numbers representing each character follows exactly a traditional
writing sequence of the character from the very first stroke to the end of the
string of code numbers. The computer usually identifies the character before the
entire writing sequence is completed. Certain aspects of our eZiText products
are based on the intellectual property covered under the 352
Patent.
  On
December 25, 2001, Taiwanese patent No. NI139820 was issued to the
Company. In January 2003, Chinese patent ZL99-1-00625.9, “Method and Apparatus
of Chinese Character Text Input,” was issued to the Company. These patents
protect the unique implementation of our Chinese language input technology on
cellular phones and other wireless devices and, in particular, protect those
combinations of elements which are of particular help to a user in improving the
speed of text creation. The Company was also granted an equivalent of this
patent in Hong Kong as patent number HK1020216 on
August 22, 2003. In addition, the Company has a number of patent applications
pending in the United States and Europe based on ideographic language input
networks and software utilities which use text as a key part of their operation.
  The
Company has received allowances of patents in Europe and China with respect to
technology that enables a user to not only select the stroke category as
described in the O’Dell patent but to also place that stroke in the desired
relative position in a character being created. This increases the speed of
input and allows inexperienced users to approach the desired character more
quickly without having to search a long list of candidates. This is much simpler
than full handwriting recognition and is compatible with low resource computing
environments typical of the cellular telephone market.
  ***Acquisition
of Oztime***
  In
October 1999, we acquired all of the shares of 845162 Alberta Ltd. (“845”) from
Oz New Media Inc. (“ONM”) in consideration for 100,000 of our common shares
issued from treasury. Immediately prior to this acquisition, ONM caused the
sale, assignment and transfer of the five percent interest in Beijing Oz
Education Network System Co. Ltd. (“Beijing Oz”) (a People’s Republic of China
joint venture company formed under the *People’s
Republic of China Foreign-Invested Business Act* ) held by
Beijing Senmo Ltd. (“Senmo”) to ONM. ONM subsequently sold, assigned and
transferred its resulting 100 percent interest in Beijing Oz to 845, making
representations and warranties to Zi of the validity of such actions. In
addition, we also advanced $375,000 for, and on behalf of, Beijing Oz to pay the
balance of the registered capital investment required under the joint venture
contract that was entered into to form Beijing Oz.
   21
  Since the
purchase of Beijing Oz, we learned that the sale, assignment and transfer of the
five percent interest held by Senmo to ONM was not properly registered with
applicable authorities in China. This resulted in a dispute with Senmo as to the
registration of such sale, assignment and transfer. Due to this dispute, Beijing
Oz was technically registered in China as a PRC joint venture company, having
five percent ownership by Senmo.
  In order
to address this situation, on July 31, 2001, the Company caused one of its
subsidiaries to incorporate Beijing Oztime Education & Network
Technology Co., Ltd. (“Oztime”), a Wholly Foreign Owned Enterprise formed under
the laws of the People’s Republic of China. Since this event, all substantive
business, including product and business development, has been carried out
through this new entity, which is intended to mitigate possible consequences of
the lack of proper Chinese registration of the Company’s interest in Beijing Oz.
Beijing Oz is currently inactive and carries on no business operations in China.
We received confirmation in 2003 that Beijing Oz has now been officially
dissolved.
  Concurrent
with the acquisition, 845 entered into a license agreement (the “845 License”)
with ONM under which 845 was appointed as the exclusive distributor and
manufacturer of the following software products in China, Japan, Korea, Taiwan,
Singapore, Malaysia and Thailand (the “Territory”): (i) Career Options
On-Line, an online educational product developed by ONM for The Alberta
Education Career and Technology Studies Curriculum; (ii) English as a
Second Language, an online educational product developed by ONM for the Chinese
market; and (iii) On-Line Webstories for Learning, an online educational
product addressing the language arts grades 3 and 4 literacy
curriculum for the United Kingdom (the foregoing products hereinafter
collectively referred to as the “Products”). Singapore and Thailand are
specifically excluded from the Territory in respect of on-line webstories for
learning. ONM granted 845, among other things, the exclusive right to use,
market, promote, distribute, sell, sublicense, manufacture and modify the
products and to use the intellectual property within the Territory and to bundle
the products with other computer programs of 845. The 845 License is for a term
of 50 years.
  We and
ONM also entered into an option agreement (the “Option”) under which we were
granted an irrevocable option to purchase all of the assets of ONM for a
purchase price of $5,000,000 exercisable at any time on or before
December 13, 1999. We did not exercise the option which has now
expired.
  ***Acquisition
of EnglishPractice Inc.***
  On
June 15, 2000, we acquired all of the outstanding shares of
EnglishPractice.com Inc., which subsequently changed its name to EnglishPractice
Inc. (“EPI”), an online content and services host for English as a Second
Language (“ESL”) training. EPI was acquired primarily to complement Oztime’s
education portal business and provide ESL content, with the possibility of EPI
independently earning revenues based upon a dotcom business model. We acquired
EPI in exchange for $226,000 cash and 250,000 of our common shares. We also
agreed to commit up to CDN$1.0 million (“EPI Funding Commitments”) in
further funding to assist in achieving certain revenue milestones. Of the shares
we issued as consideration, 80,000 Zi shares were issued to the EPI founders
upon closing and the remainder were escrowed pending achievement of the revenue
milestones. Certain of the EPI founders were retained as employees as part of
the acquisition.
  EPI owns
two proprietary software products: (i) The Lesson Manager; and
(ii) The Content Generator. The Lesson Manager allows teachers to enter
questions and quizzes through a user friendly interface and the Content
Generator converts the content entered into Java applications and corresponding
HTML pages. EPI had over 570,000 users and over 6 million page views
per month at the time of acquisition. EPI’s revenue model was based on growing
and leveraging its user base to receive revenues from advertising, sponsorship,
pay per use, subscription and e-commerce opportunities. This revenue model has
not proven to be effective and revenue streams have not developed since
acquisition. We do not believe that EPI will contribute any material revenues to
us in the future as a stand alone entity. As a result, EPI content and software
products have been integrated into Oztime’s education portal
business.
   22
  In
December 2000, we and the EPI founders agreed that the EPI revenue milestones
required to release the Zi shares held in escrow would not be met. As a result,
the purchase agreement was amended to cancel the balance of EPI Funding
Commitments, to immediately cancel 85,000 of the escrowed Zi shares, to amend
the milestones for release of escrowed shares and to release 45,000 of the
escrowed Zi shares over the period from May 30, 2001 to May 30, 2002.
The balance of 40,000 escrowed Zi shares (Performance Shares) remaining in
escrow are in the course of being cancelled following the expiry of the escrow
period due to the non-fulfilment of the milestones for release of the remaining
escrowed shares **.**
  In late
2001, the EPI operations were moved from Calgary to share offices with Oztime in
Beijing and EPI’s technology and business has been integrated into Oztime’s
business plan. See *Item 4 -
Information on the Company - B. Business Overview* .
  ***Acquisition
of Assets of Decuma AB***
  On
January 26, 2005 the Company acquired the assets of handwriting recognition
software specialists Decuma AB of Lund, Sweden. As part of the acquisition, the
Company acquired the intellectual property and customer agreements of privately
held Decuma. The purchase price was approximately US$1.0 million paid in 146,929
common shares of the Company.
  ***Intellectual
Property Litigation***
  In the
course of its operating history, the Company has been involved in several
lawsuits, both as a plaintiff and as a defendant, with its largest competitor,
Tegic Communications, Inc., which is a subsidiary of AOL (“Tegic”). The
following is an overview of these proceedings:
  *(i)*
    *Asian
      Communications Pty Ltd., and Tegic Communications, Inc. v. Zi Corporation
      and Zi Corporation of America, Inc.*Pursuant
      to a Complaint for Patent Infringement filed on March 21, 2000 in the
      United States District Court in and for the Northern District of
      California, Asian Communications Pty. Ltd. (“Asian Communications”) and
      Tegic alleged that the Company and its affiliate, Zi Corporation of
      America, Inc.(“Zi America”) infringed certain Tegic patents in the United
      States ( the “Tegic Lawsuit”).
  On
February 21, 2002, the District Court granted a summary judgement order
which held that the Company’s then current version 4.5 eZiText product for
alphabetic languages did not infringe the Tegic patents in this
lawsuit.
  The trial
in this action was held in August, 2002. On September 4, 2002, the jury in
this lawsuit found that certain versions earlier than version 4.5 of the
Company’s eZiText product infringed Tegic’s US patents and awarded Tegic
$9 million in damages ( the “Damages Award”) At a post-trial hearing held
on November 8, 2002, the presiding trial judge in this lawsuit upheld the
jury’s damages verdict and denied the Company’s motions to invalidate Tegic’s US
patents and to set aside the Damages Award.
   23
  The
Company settled all claims in this lawsuit with AOL by a written settlement
agreement dated December 6, 2002. The settlement of this lawsuit deals with
patent infringement claims in the United States. As part of the settlement, a
Consent Judgement was entered on December 20, 2002. The settlement in
relation to the US Restricted Versions of eZiText prohibits the sale or any use
of such products by the Company in the United States only. The sale, use and
licensing of such versions of the Company’s eZiText product by the Company and
its affiliates in countries other than the United States is not affected. The
ability of the Company and its affiliates to sell, license and make use of its
eZiText product (all versions) in all countries of the world, including the
United States, is not limited or restricted by the settlement.
  *(ii)*
    *Asian
      Communications Pty. Ltd. and Tegic Communications, Inc. v. Zi Corporation
      (Hong Kong) Ltd.*The Company was also served with a Writ of Summons filed on March 30,
      2000, by Asian Communications and Tegic in the High Court of the Hong Kong
      Special Administrative Region Court of First Instance seeking, among other
      things, a declaration that one of the plaintiffs’ patents is valid and
      that the same has been infringed by Zi. A Statement of Claim dated
      May 10, 2000 was subsequently served on the Company. We are defending
      this lawsuit and filed a Defence and Counterclaim. To date, to the best of
      the Company’s knowledge, no further action or proceeding has been
      undertaken in this lawsuit by either party.
  ***Dispositions
and Discontinued Operations***
  Telecom
Technology Corporation Limited
  On
July 22, 2000, we acquired all of the outstanding shares of Telecom
Technology Centre, Limited (“TTC”), an engineering and design services provider
in exchange for $3,208,023 in cash. The acquisition cost was offset in part by
TTC’s cash position of $1,305,877. As a result of this acquisition, we added
over 30 Hong Kong based telecom technology engineers with the ability to
develop and produce customized solutions for BluetoothTM applications, Wireless
Access Protocol (WAP) and VoIP.
  TTC was
established in 1995 through project funding from the government of Hong Kong
Special Administrative Region and was, at the time of acquisition, one of Hong
Kong’s largest telecom technology and engineering organizations. TTC’s original
mandate was to provide electronic design solutions for the local Hong Kong
Ministry.
  After the
acquisition was completed, TTC changed its name to Telecom Technology
Corporation Limited on September 29, 2000.
  Subsequent
to the acquisition, TTC was integrated into our wholly-owned subsidiary, Zi
Corporation (H.K.) Limited. As part of this integration, Zi Services’ various
business lines were narrowed to focus specifically on developing Bluetooth and
VoIP technologies.
   24
  
 Due to
what we perceived as a lack of market demand for the emerging technologies of
Bluetooth and VoiP at that time, the Company closed its Zi Services business
unit in December 2002, terminated all employees and liquidated all of the assets
of this business unit to a third party for proceeds of $220,000.
  The
Magic Lantern Group of Companies
  On
March 19, 2002, Zi acquired MagicVision Media Inc. (“MagicVision”), a
company formed by the senior management of Magic Lantern Communications Ltd.
(“Magic Lantern”) and its primary holding, Magic Lantern, together with Magic
Lantern’s 100 percent interest in Tutorbuddy Inc. (“Tutorbuddy”) and
75 percent interest in Sonoptic Technologies Inc. (“Sonoptic”)
(collectively referred to as the “Lantern Group”). The Government of New
Brunswick owns 25 percent of Sonoptic. Zi acquired MagicVision by issuing
100,000 common shares of Zi (35,000 of these shares which were subject to
performance escrow based on revenue targets being achieved and have since been
cancelled) and paying approximately $1.6 million to subscribe for shares of
MagicVision. Of these subscription proceeds, $1.2 million was used to
facilitate the buyout by MagicVision of Magic Lantern and its subsidiaries from
the previous owners. The remainder of the subscription proceeds were used
principally to pay the fees of an advisor retained by MagicVision and to pay a
portion of MagicVision’s legal fees. The founders and key employees of the Magic
Lantern group of companies were retained at that time. Magic Lantern was
acquired to give Zi a North American based company with which to leverage its
relationships in China and capitalize on our Oztime e-learning
investment.
  On
November 7, 2002, the Company completed the sale of 55% of its interest in
the Lantern Group to JKC Group Inc., which was believed to be an arm’s-length
party. As part of the transaction, JKC Group Inc. changed its corporate name to
Magic Lantern Group, Inc. (“MLG”). MLG trades on the AMEX under the ticker
symbol “GML”. At closing, the Company received a 45% equity interest in MLG
consisting of 29,750,000 common shares and a three year promissory note in
the face amount of $3,000,000. The Company obtained registration rights for its
stock in MLG and its stock has been registered with the Securities and Exchange
Commission for trading. The promissory note was subject to adjustment based upon
the financial performance of the Lantern Group for the first year after the
sale. As a result of the level of MLG’s financial performance during the year
subsequent to closing, the face amount of the note has been reduced to
$2,000,000.
  Subsequent
to the closing, it was learned that MLG’s then-controlling shareholder, an
affiliate of Michael Lauer and several funds known as the Lancer Group, on an
undisclosed basis, had acquired what was subsequently disclosed to be a 49.3%
interest in Zi. There is no material impact on the financial statements of Zi as
a result of the sale of the Lantern Group, to what is now known to be a related
party, since no gain was recognized on the disposition of the Lantern
Group.
  In the
fourth quarter of 2004, the Company took an impairment charge with respect to
the MLG note as a result of publicly-available financial information about MLG
(including the going concern qualification to its financial statements) and the
failure of MLG to make scheduled interest payments on the notes.
  Possible
Divestiture of Oztime and EnglishPractice
  As of the
date of this Report, the Company is seeking to divest Oztime and EnglishPractice
through a series of transactions in which (i) the Company will transfer the
shares of Oztime and EnglishPractice to a new company, Archer Education Group
Inc. (“Archer”), (ii) Archer will seek outside equity investment for Archer, and
(iii) Archer will seek to implement a business plan which includes complementary
acquisitions in the language and
lifelong  learning
industry. While there are a number of letters of intent with respect to these
transactions, the letters of intent are non-binding and there can be assurance
that the Company will be successful in divesting Oztime and EnglishPractice.
   25
 
 ***Acquisition
of Zi Shares by the Lancer Funds***
  In early
July of 2003, a U.S. federal judge froze the assets of certain Lancer Funds and
appointed an attorney in the law firm of Hunton & Williams, LLP as receiver
for Lancer Management Inc., and related entities. The Company reported in its
Form 20-F for the year 2001, based on information provided by Lancer, that
Lancer and its affiliated companies held or controlled directly or beneficially
Zi stock totalling 3,675,100 shares, which represented approximately 9.67
percent ownership in the Company. In the course of preparing the Form 20-F for
the year 2002, management of the Company observed what appeared to be a
concentration of its shares held at a major brokerage firm. Management requested
that its attorneys obtain an update from Lancer concerning the level of Lancer
ownership in the Company, but despite several requests, did not receive a
response.
  Accordingly,
the Company reported in its Form 20-F for 2002, dated May 15, 2003, the same
information about Lancer’s share ownership in Zi that was disclosed in its 2001
Form 20-F and disclosed in the 2002 Form 20-F that it had been unable to obtain
current information regarding Lancer’s holdings and that its holdings may be
greater or less than reported.
  The court
appointed receiver (and the party in control with respect to the Lancer Funds
under creditor protection; collectively referred to herein as the “Receiver”)
filed an initial report on September 8, 2003 in the U.S. District Court in
Florida, noting, among other things, that numerous substantial investment
position discrepancies had been identified in many of the funds' holdings. The
Receiver remained uncertain of the funds' ownership interest in many of those
portfolio companies, including the Company. The initial report also disclosed
that the Receiver could apply to the court for abatement of its obligation to
make regulatory filings with the U.S. Securities and Exchange Commission or
other appropriate agencies. The Company offered assistance to the Receiver to
determine the extent of the Lancer Fund holdings in the Company, including the
provision of copies of its registered shareholder records.
  On
December 3, 2003, a statement of beneficial ownership on Schedule 13D was filed
by the Receiver with the SEC. According to the Schedule 13D, the receiver
reported that it owned, through four Lancer entities, 19,407,364 common shares
of the Company, or approximately 49 percent of the total issued and outstanding
common shares of the Company.
  Under the
United States Securities Act of 1933, the Receiver is deemed to be an affiliate
of the Company and its holdings in the Company are therefore subject to resale
restrictions absent registration under the Securities Act. Under U.S. law, the
amount of securities that may be publicly sold in the United States by an
affiliate within any three-month period may not exceed the greater of one
percent of the total number of Company shares outstanding, or the average weekly
reported volume of trading in Company shares during the four weeks prior to the
filing of a notice with the SEC of an intention to sell. The volume limitation
does not apply to sales by the Receiver on the Toronto Stock
Exchange.
   26
  The
following is an excerpt from the Schedule 13D filed December 3,
2003:
  *"The
purpose of the appointment of the Reporting Person as Receiver was to administer
and hold the assets of the Receivership Entities. In the course of the
administration of the assets of the Receivership Entities, the Reporting Person
has hired an investment manager and has charged its investment manager generally
with the task of proposing strategies for maximizing the net present value
obtainable from the assets of the Receivership Entities over the next five
years. The Reporting Person currently does not intend to dispose of a
substantial portion of the Common Stock of the Issuer held by the Receivership
Entities in the public markets. The Reporting Person may from time to time seek
to sell or transfer a limited amount of the Common Stock of the Issuer held by
the Receivership Entities in the public markets based on its evaluation of the
business prospects of the Issuer and upon other factors, including but not
limited to, general economic and business conditions and stock market
conditions."*
  On
January 11, 2005, the Receiver filed an intention to sell in the aggregate up to
3,363,396 common shares in the ninety days thereafter pursuant to Rule 144 under
the U.S. Securities Act of 1933. According to an Amendment to the Schedule 13D
dated January 28, 2005, the Receiver sold 439,895 shares on January 19,
2005.
  *Principal
Capital Expenditures and Divestiture*
  During
the years ended December 31, 2001, 2002, 2003, 2004 and up to March 23,
2005 our principal capital expenditures were as follows:
  **Amount
      of Expenditure (Divestiture)****Description
      of Expenditure**
    
    **To
      March23, 2005**
    
    **2004**
    
    **2003**
    
    **2002**
    
    **2001**Capitalized
      Software Development
      Costs
    
    $
    112,740
    
    $
    1,661,974
    
    $
    237,618
    
    $
    452,573
    
    $
    4,700,669Acquisition
      of Decuma
    
    $
    930,870
    
    
    Nil
    
    
    Nil
    
    
    Nil
    
    
    NilAcquisition
      of Magic Lantern
    
    
    Nil
    
    
    Nil
    
    
    Nil
    
    $
    1,600,627
    
    
    NilComputer &
      office equipment
    
    $
    26,524
    
    $
    178,258
    
    $
    133,297
    
    $
    922,171
    
    $
    809,827
 
  During
the years ended December 31, 2001, 2002, 2003, 2004 and up to March 23,
2005 the Company did not have any significant capital divestitures other than
the disposition in 2002 of the Magic Lantern Group of Companies as previously
described and its accumulated capital investment of $2,220,687.
  See *Item 18 -
Financial Statements - Note 3* for a
detailed description of the acquisitions.
  In
January 2005, the Company acquired the assets of Decuma AB for approximately
US$1.0 million, including fees and expenses. In the remainder of 2005 the
Company’s planned principal capital expenditures will be software development
costs. The Company expects these expenditures will be incurred primarily in
Canada and Sweden.
   27
  ***B.*** ***Business
Overview***
  *Zi
in General*
  The
business of our Company is organized as follows.
  The
principal business unit of the Company is the Zi Technology business unit in
which our core eZiText business is carried on. Our core technology product,
eZiText, and its companion application, eZiTap, are predictive text input
solutions that predict words and/or phrases for use in messaging and other text
applications in 48 languages and dialects. By offering word candidates as
text is being entered, eZiText increases the ease, speed and accuracy of text
input on electronic devices for applications such as short messaging, e-mail,
e-commerce and Web browsing. In January 2005, we acquired the assets of
handwriting recognition software specialists Decuma AB. In February 2005 we
announced a new product, Qix, a new application interface that provides users
with a quick and easy method for accessing and discovering a phone's full set of
features, applications and services without having to remember where and how to
find them via the phone's built-in menu structure. Qix intuitively accesses
information directly from the idle screen used for dialing on the standard
keypad. Qix significantly reduces the number of key presses needed to use a
phone and eliminates the need to scroll through complex menu
systems.
  In
addition to our Zi Technology business unit, we hold two separate investments in
e-Learning. As discussed above in *Item
4A - History and Development of the Company* , we hold
a substantial minority equity interest in MLG which owns and operates the
business of the Magic Lantern Group of Companies in the e-Learning field in
North America. We also hold a 100% equity interest in Oztime which includes
EnglishPractice and carries on business activities in the e-Learning field in
Asia and integrates the business activities of EnglishPractice in North America.
Together, these investments in e-Learning business provide e-Learning
technology, content and customer service as well as educational content and
distribution channels to offer learning management systems, interactive online
courses and network education solutions to meet diverse client
requirements.
  ***Zi
Technology Business Unit***
  Description
of eZiText and eZiTap
  Although
eZiText can be used in 48 written languages, it was initially developed in
an effort to resolve the problem of inputting ideographic-based languages, such
as Chinese, into a computer or other electronic device with an alphanumeric
keyboard. The following example illustrates how eZiText Chinese is applied to
resolve this challenge and illustrates how the principles of eZiText Chinese can
also be applied to alphabet-based languages.
  When
learning Chinese, students are taught to write each character manually using a
precise stroke order which has been developed over hundreds of years. eZiText
Chinese relies on this knowledge of stroke order and uses a limited number of
keys (for example, 5 keys or 8 keys) to enable a user to input
different strokes to electronically “draw” Chinese characters. For instance, to
call up a specific Chinese character, a user presses the applicable key for the
first stroke used when writing that character. The software then calls up a list
of the most common characters beginning with that stroke and displays those
characters on the screen. If the character the user is writing is among those
displayed on the screen, the user then selects that character by pressing a key.
If the character is not in that list, the user then presses the key for the next
applicable stroke and is supplied with another list of characters based on that
combination and order of strokes.
   28
  Each time
a key representing a stroke is pressed, eZiText Chinese makes an analysis which
predicts the character the user is entering. On the first key press, the
analysis is based on the frequency of use of individual characters. But as more
strokes are entered and more characters are selected, the algorithm becomes more
sophisticated, giving a user subsequent or associated characters on the basis of
meaning, style and syntax in addition to frequency of use. The most likely
choice appears under the cursor for immediate selection. While the average
number of strokes required to draw a Chinese character is approximately 14,
eZiText Chinese algorithms allow Chinese text to be entered with generally fewer
than 3 key strokes per character. Furthermore, eZiText Chinese goes beyond
single character completion, offering predictive word completion (as some of
Chinese words consist of more than one character) and even phrase
completion.
  eZiText
Chinese has evolved. In addition to offering completed characters, eZiText
Chinese also considers partial character structures that could be created with
the entered sequences and displays these as well. Thus when a user is confronted
with having to enter a character that is infrequent, the ability to select the
structural aspect as controlling parameter greatly simplifies use. This
particular aspect is part of Zi’s Chinese Patent ZL-99-1-00625.9 and is believed
to be popular with the user community.
  Because
of the structures of alphabetic languages, eZiText for Latin-based languages
does not attempt to offer candidates to the user at the first key press unless
the entered key is a valid single letter word such as ‘a’ or ‘I’ in English.
Instead, eZiText waits until a second keypress is made whereupon candidates are
offered which are of significantly better quality than otherwise seen. This is
an implementation more suited to the way that a typical user interacts with the
display of the device.
  eZiText
can now be used in the following languages: Arabic, Bulgarian, Chinese (PRC,
Hong Kong and Taiwan), Croatian, Czech, Danish, Dutch, English (British,
American and Asian), Estonian, Farsi, Finnish, French (European and Canadian),
German, Greek, Hebrew, Hindi, Hungarian, Icelandic, Indonesian, Italian,
Japanese, Korean, Latvian, Lithuanian, Malay, Norwegian, Polish, Portuguese
(European and Brazilian), Romanian, Russian, Serbian, Slovak, Slovenian, Spanish
(European and Latin American), Swedish, Tagalog, Thai, Turkish, Ukrainian and
Vietnamese.
  Our
software technology is incorporated by reference design and chipset providers,
total solution providers, operating system developers, hardware manufacturers
and other businesses into their respective electronic, wireless and computer
devices, providing end users with a device that is language-enabled for
text-entry. eZiText technology is distributed through licensing
agreements.
  In 2003,
Zi released new versions of eZiText and eZiTap to deliver additional benefits to
the user, device manufacturer and network operator. For the user, new features
deliver increased text input speed and more opportunities for personalized text
entry. For a device manufacturer, additional memory efficiencies, software
enhancements and new man-machine interface (MMI) capabilities support learning
and prediction with less memory. For a network operator, improved text entry
speed and capabilities promote more utilization of services such as short
messaging, multi-media messaging, web-browsing and more.
  Additional
benefits include a new language database architecture that expands a language
database’s word list without increasing overall memory size; reduced memory
footprint through new algorithms and improved compression; improved text entry
speed that reduces the number of key presses and additional features such as
phrase prediction, dual (simultaneous) language messaging, prediction of data
from other sources such as the phonebook, contact list, and web URL’s, among
others, to provide faster, more natural text entry. The Company expects that
these new releases, together with further enhancements or developments, will be
central to its ability to penetrate further into the market in the next several
years.
   29
  Moreover,
Zi made significant progress in its integration of core products and the
development of solutions for Smart Phone platforms, a major growth segment of
the wireless device market. The Company has developed Input Method Editors
(“IMEs”) for eZiText and eZiTap for the Microsoft Windows Mobile platform and
eZiText and eZiTap Front End Processors (“FEPs”) for Symbian Series 60 and
Palm-based smart phones. These solutions enable OEMs easy access to Zi’s core
products on leading smart phone platforms.
  In 2002,
Zi announced its development of a network-based platform that enables the
integration of wireless communication devices with the network called eZiNet. In
2003, the Company focused the majority of its effort on the development and
expansion of its core products, eZiText and eZiTap, and did not undertake
significant incremental effort to develop or license eZiNet.
  However,
we believe the eZiNet product category and related concepts continue to provide
a visionary, forward-looking perspective for new products, resulting in
incremental spin-offs such as a downloadable version of eZiTap for the Sony
Ericsson P800 and P900 smart phones. Accordingly, the Company believes that it
has the tools to extend its distribution potential for its text entry products.
Distribution of certain versions of Zi’s software over the Internet using
reputable third party distributors, such as Handango, allow end-users of
handsets to download Zi products and provide direct payment online.
  Licensing
of eZiText
  As of
March 23, 2005, Zi has entered into licenses with over 100 licensees who
are typically original equipment manufacturers to embed eZiText into their
respective products. These licensees include among others, cellular phone
manufacturers, set-top box manufacturers and personal digital assistant
manufacturers.
  To the
best of our knowledge, approximately 57 licensees have completed
implementation of eZiText to date on at least one of their respective products.
The majority of our revenues are derived from licensing agreements. In addition
to licensing of our technology, we have also entered into various strategic
alliances to expand the reach of our technology. In 2004, we derived
approximately 96 percent of our total revenue from eZiText licensing fees
and royalties. The majority of our eZiText customers are OEMs for cellular
telephones. The majority of licensees pay us, among other fees, a royalty fee
for every unit upon which eZiText is embedded. The royalty amount varies from
customer to customer and varies in accordance with unit volumes produced by the
licensee. Since cellular phones are consumer products, our revenues are subject
to seasonality associated with cellular phone sales and are highly dependent on
the market presence, marketing prowess, manufacturing and distribution
capabilities of the OEMs, and consumer acceptance and demand for our licensees’
finished cellular telephone product. In the year ended December 31, 2004,
two customers, Kyocera Corporation and Nokia Corporation, accounted for
34 percent of our total revenue.
  Description
of Qix
  
 30
 
 
 In
February 2005 at the annual 3GSM conference in Cannes, France, the Company
launched its new Qix application interface that sits on top of user-platform
environments and operating systems. Qix provides a quick and easy method for
accessing a phone’s full set of features, applications and services without
having to remember where and how to find them via a phone’s built-in menu
structure. Qix intuitively accesses a phone’s features directly from the
idle/dialing screen using the standard keypad . Qix is
currently in beta testing and is expected to be commercially available in late
2005.
  Description
of Decuma Handwriting Recognition Solutions
  In
January 2005 we acquired the assets of Decuma AB of Lund, Sweden. Decuma’s
handwriting recognition solutions consist of Decuma Alphabetic, Decuma Japanese
and Decuma Chinese.
  Decuma
Alphabetic is modeled closely to actual writing with pen on paper. A single
input area is used for writing and presenting recognized letters and for editing
the text. This makes input natural and fast, and allows the user to focus on the
content rather than the writing. Users do not have to learn or adjust to a
certain writing style or learn a special alphabet. Uppercase and lowercase
characters, digits, punctuation marks and special symbols, as well as accented
characters, can be mixed in the same input mode.
  Editing
is done directly in the input area using intuitive gestures to delete or insert
one or several characters. Shortcuts can be added with personal symbols and
characters for convenient input for frequently written phrases and
commands.
  Decuma
Alphabetic currently supports Albanian, Danish, Dutch, English, Finnish, French,
German, Icelandic, Irish, Italian, Luxembourgish, Norwegian, Portuguese, Spanish
and Swedish characters as well as different writing styles in these
languages.
  The
Decuma Japanese handwriting recognition application allows for input of both
Kanji and Kana characters. It also supports input of handwritten Latin letters,
numerics, and punctuation. The input method is compliant with standard
conversion applications.
  Decuma's
Chinese handwriting recognition software handles natural variations in Chinese
writing: printed, semi-cursive and common cursive styles. The recognition engine
has the smallest memory footprint on the market, requiring less than 30 percent
compared to others. The Decuma Chinese input method supports word-by-word input
and mimics the natural writing process. In mainland China and Singapore, a
simplified form of the traditional Chinese characters is employed, where nearly
7,000 characters are used instead of the traditional Chinese character set which
contains around 13,000 characters. Traditional characters are used in Taiwan and
Hong Kong and there are also some Hong Kong- and Shanghai-specific characters.
Decuma's recognition software includes databases for both simplified and
traditional Chinese, as well as the region-specific characters.
  In
Chinese writing, numbers and Latin alphabetic characters are regularly used.
Using the Decuma Chinese input method, Chinese and Latin characters, as well as
numbers, are conveniently written in the same input boxes. Punctuation symbols
can also be written without switching to any special input mode. This greatly
facilitates the writing process and mimics the natural Chinese writing
style.
  The
software is compatible both with most Palm OS 5 devices with a high resolution
display, and all Pocket PC devices. It has been tested on several of them
including Compaq iPaq 3600/3700/3800, HP Jornada, Fujitsu-Siemens Pocket Loox
and Toshiba Genio 5500. In March 2005 the general availability of Decuma
Alphabetic software was announced for the Sony Ericsson P800/900/910 series of
smartphones.
   31
  Investment
in Oztime
  Our
Oztime subsidiary represents our investment in China’s e-Learning market. Oztime
was organized by the Company in July 2001. See *Item 4 -
Information on the Company - Acquisition of Oztime.* In the
past 24 months, Oztime has refined its business focus, transformed its
senior management team to better address the development of its evolving
businesses, and has integrated EnglishPractice as part of its business. Based in
Beijing with over 50 employees, Oztime currently focuses on the development
of 3 main business areas:
  ·
    **Learning
      Management System (“LMS”)**-
      Amethi 2.0 is Oztime’s flagship learning management system software
      designed for the Chinese market. It is a complete LMS, written entirely in
      Chinese and suitable for a wide range of Chinese organizations and
      institutions of higher learning.
  ·
    **Building
      Online Courseware**-
      Oztime builds Storable Content Object Reference Model (SCORM) compliant
      custom e-Learning courseware based on client materials and offers Chinese
      language standard courseware in the area of project management, business
      fundamentals and business English.
  ·
    **English
      Teaching on the Internet**-
      Working with the intellectual property from EnglishPractice, Oztime is
      distributing English as a Second Language (“ESL”) on the Internet through
      a variety of channels in China. English teaching is in high demand in
      China and the Internet is increasingly becoming a medium for teaching and
      learning.
  Oztime’s
clients for its current products include the People’s Liberation Army, National
Statistics Bureau, Zhejiang Electric, Hainan High Court and Lenovo. Oztime is
focused on expanding this client list in each of its three business areas.
  Oztime’s
business is subject to the laws and regulations governing the PRC. The Internet
industry is heavily regulated in China. The State Council and Ministry of
Information Industry periodically promulgate regulations related to the Internet
to address public policy considerations. There can be no assurance that the
Chinese government will not attempt to regulate on-line education programs or
educational content. Such regulation may have an adverse effect on Oztime and
our business.
  The
Company is actively seeking to divest its interest in Oztime, consistent with
achieving value for the Company and its shareholders.
  Investment
in MLG
  The
Company holds an approximate 44 percent interest in. The primary operating
company in the Magic Lantern Group, Magic Lantern Communications Ltd. (“Magic
Lantern”), was founded in 1975 and is a distributor of educational content,
primarily distributing videos to educational institutions. Magic Lantern has
exclusive distribution rights to over 300 film producers representing over
14,000 titles, and its customers include 9,000 of 12,000 English
schools in Canada, Canadian Learning Television, TV Ontario and History
Television. Magic Lantern’s subsidiary, Tutorbuddy Inc., is an Internet based
content delivery service that aims to provide content and related educational
services on demand to students, teachers and parents. Magic Lantern holds a
75 percent interest in Sonoptic Technologies Inc. Sonoptic provides high
quality, state-of-the-art digital video encoding services and has developed a
proprietary video base indexing software that allows users to easily and quickly
aggregate, bookmark, e-sort and add their own comment boxes to pre-existing
content.
   32
  The
Company intends to monetize its interests in MLG, as market conditions permit,
to focus on its Zi Technology business unit.
  Geographic
Segments
  The table
below summarizes the Company’s revenues by activity and geographic market for
the last three fiscal years:
  **Revenue****License
      and implementation fees**
    
    **Software
      and other**
    
    **Total****2004**
    
    
    Canada(1
    )
    **$******
    ******5,884,396**
    
    **$******
    ******8,120**
    
    **$******
    ******5,892,516**China(2
    )
    
    **5,207,579**
    
    
    **496,093**
    
    
    **5,703,672**USA(3
    )
    
    **1,806,863**
    
    
    —
    
    
    **1,806,863**Total
    
    **$******
    ******12,898,838**
    
    **$******
    ******504,213**
    
    **$******
    ******13,403,051**2003
    
    
    Canada(1
    )
    $
    3,731,859
    
    $
    13,982
    
    $
    3,745,841China
    
    
    3,378,770
    
    
    670,088
    
    
    4,048,858USA(3
    )
    
    2,808,369
    
    
    —
    
    
    2,808,369Total
    
    $
    9,918,998
    
    $
    684,070
    
    $
    10,603,0682002
    
    
    Canada(1
    )
    $
    2,315,344
    
    $
    1,638,898
    
    $
    3,954,242China
    
    
    1,368,614
    
    
    296,411
    
    
    1,665,025USA(3
    )
    
    2,796,980
    
    
    —
    
    
    2,796,980Total
    
    $
    6,480,938
    
    $
    1,935,309
    
    $
    8,416,247
 
 ****
 **Note** **s:**
  (1)
    The
      actual geographic markets for the products licensed under licensing
      agreements between OEMs and Zi Corporation of Canada, Inc. are in Asia and
      Europe.
  (2)
    Other
      product revenue recorded by the Company is mainly comprised of revenue for
      the e-Learning business segment.
  (3)
    The
      actual geographic markets for products licensed under licensing agreements
      between OEMs and Zi Corporation of America, Inc. are in Asia and the
      United States.
   33
  March 23,
2005. Unless otherwise indicated, Zi, or one of its subsidiaries, owns
100 percent of the outstanding shares of the subsidiary.
  **Name
      of Subsidiary**
    **Country
      of Incorporation**Multi-Corp
      International Ltd.
    BarbadosZi
      Corporation of Canada, Inc.
    CanadaZi
      Corporation of America, Inc.
    USAAsia
      Translation & Telecommunications Limited
    Hong
      KongZi
      Corporation (H.K.) Limited
    Hong
      KongHuayu
      Zi Software Technology Limited.(1)
    Hong
      KongHuayu
      Zi Software Technology (Beijing) Co., Ltd.(2)
    ChinaEnglishPractice
      Inc.
    Canada845162
      Alberta Ltd.
    CanadaBeijing
      Oztime Education & Network Technology Co., Ltd.
    ChinaZi
      Oztime Corporation Ltd.
    BermudaZi
      (Bermuda) Corporation Ltd.
    BermudaZi
      Technology Corporation Ltd.
    BermudaTelecom
      Technology Corporation Limited
    Hong
      KongMagic
      Lantern Group, Inc.(3)
    USAZi
      Decuma AB
    SwedenArcher
      Education Group, Inc.
    Canada
 
 **Note** **s:**
 (1)
    Zi
      Corporation (H.K.) Limited holds eighty-five percent (85%) of Huayu Zi
      Software Technology Limited. The balance of fifteen percent (15%) is held
      by China Huayu (Hong Kong) Limited, a third party
  investor.
 (2)
    Huayu
      Zi Software Technology (Beijing) Co., Ltd., is wholly owned by Huayu Zi
      Software Technology Limited.
 (3)
    Zi
      Corporation holds forty-four percent (44%) of Magic Lantern Group,
      Inc.
   34
 
 ***C.*** ***Property,
Plant and Equipment***
  Our
current facilities include administrative and sales offices, and engineering
offices. The table below describes our material properties:
  **Location**
    
    **Purpose**
    
    **Owned
      or leased**
    
    **Approximate
      squarefootage**Calgary,
      Alberta
    
    Corporate
      head office and engineering office
    
    Lease
      expires June 30, 2007
    
    13,348 sq
      ftDenver,
      Colorado
    
    Head
      office for Zi Corporation of America
    
    Lease
      expires December 31, 2005
    
    500
      sq ftWalnut
      Creek, California(1)
    
    North
      American sales office
    
    Rental
      license
    
    300 sq
      ftHong
      Kong, SAR
    
    Asia
      Pacific sales and engineering office
    
    Lease
      expires November 14, 2006
    
    1,835 sq
      ftBeijing,
      PRC
    
    PRC
      sales and engineering office
    
    Lease
      expires May 31, 2007
    
    4,994 sq
      ftBeijing,
      PRC
    
    Oztime
      office
    
    Lease
      expires October 14, 2006
    
    8,138 sq
      ftLund,
      Sweden
    
    Corporate
      head office and engineering office for Decuma
    
    June
      30, 2005
    
    4,306
      sq ft
  **Note** **:**
  (1)
    License
      entered into as of January 1, 2004 and renews automatically every three
      months.
  We
believe our facilities are adequate for our operations and have no plans to add
facilities during the remainder of 2005.
  Operating
and Financial Review and Prospects
  The
following table summarizes certain of our selected financial information (stated
in thousands of US dollars) prepared in accordance with US GAAP. The information
in the table was derived from the more detailed financial statements for the
fiscal year ended December 31, 2002 through the fiscal year ended December 31,
2004, inclusive, and the related notes, and should be read in conjunction with
the financial statements and with the information appearing under the headings *“Item
5 - Operating and Financial Review and Prospects” and “Item 18 - Financial
Statements”.*
   35
  **Item 5** **-**
  For
      the years ended December 31 (thousands except per share
      amounts)
    
    2004
    
    2003
    
    2002Revenue
    
    $
    13,403
    
    $
    10,603
    
    $
    8,416Gross
      margin
    
    
    12,931
    
    
    10,168
    
    
    7,361Net
      loss from continuing operations
    
    
    (2,388
    )
    
    (2,931
    )
    
    (19,498
    )Discontinued
      operations
    
    
    —
    
    
    —
    
    
    (5,708
    )Net
      loss
    
    $
    (2,388
    )
    $
    (2,931
    )
    $
    (25,206
    )Total
      assets
    
    $
    21,699
    
    $
    10,686
    
    $
    11,870Net
      loss per share from continuing operations - basic and
    diluted
    
    $
    (0.06
    )
    $
    (0.08
    )
    $
    (0.52
    )Net
      loss per share - basic and diluted
    
    $
    (0.06
    )
    $
    (0.08
    )
    $
    (0.67
    )Outstanding
      shares, weighted average
    
    
    41,373
    
    
    38,720
    
    
    37,767Outstanding
      shares, end of period
    
    
    45,225
    
    
    39,372
    
    
    37,914
 ***A.*** ***Operating
Results***
 
 All
dollar amounts are in US dollars and in conformity with US GAAP. This
information should be read in conjunction with the Company’s financial
statements and notes.
  Zi
Corporation is a global technology company that delivers intelligent interface
solutions to enhance the user experience of wireless and consumer technologies.
Zi’s product innovations are available on mobile phones, PDAs, gaming devices
and set-top boxes. Zi solutions are designed to improve the usability of these
devices and the applications on them; including, SMS, MMS, e-mail and Internet
browsing.
  The
Company provides device manufacturers and network operators with a full range of
intuitive and easy-to-use solutions, including: eZiText® for one-touch
predictive text entry; eZiTapTM for intelligent multi-tap entry, Decuma® for
natural handwriting recognition and soon, the recently announced QixTM user
application interface to enhance the user experience and drive service usage and
adoption. Zi’s product portfolio includes 48 different language databases, 70
additional language interfaces and the ability to meet user needs in more than
130 countries.
  Zi has a
global presence with more than 103 million handset units using its technology in
the market worldwide. Today, there are over 800 device models in the market
embedded with Zi's technologies.
  With over
100 handset manufacturing customers, Zi’s technologies can be found in the
handsets of manufacturers from around the world, including Nokia, Sony, Sony
Ericsson, Samsung, LG Electronics, Flextronics, HP, Sanyo, Fujitsu, Kyocera and
others.
 
 
 36
  The early
2005 acquisition of Decuma handwriting recognition and the launch of the Qix
user application interface product to Zi’s core predictive text solutions of
eZiText and eZiTap is expected to further bolster Zi’s competitive advantage and
enable Zi to deliver an expanded suite of innovative products to customers.
  Zi signed
important licensing agreements in 2004, including Nokia - the world’s largest
handset manufacturer and Flextronics - the world’s largest Electronics
Manufacturing Services (EMS) provider. In Asia, Zi continues to make progress
with new agreements with leading Chinese manufacturers, including Panda Mobile
Communications, China Putian and others. In 2004, Zi also expanded into the
mobile gaming device market with a licensing agreement with Gizmondo.
  In 2004,
Zi completed pre-integration work with Series 60, an industry leading platform
from Nokia. Zi is now pre-integrated on all major mobile operating systems
(“OS”) and platform providers for smartphones, including Series 60, the Symbian
OS, Microsoft Smartphone and the PalmSource OS. Zi also collaborated with
QUALCOMM to make the eZiText Adaptation Kit for QUALCOMM’s BREW solution
commercially available to Qualcomm manufacturing licensees through QUALCOMM.
  **Critical
Accounting Policies and Estimates**
  The
preparation of these consolidated financial statements and related disclosures
in conformity with US GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of these financial statements, and
revenue and expenses during the period reported. Estimates include allowance for
doubtful accounts, valuation of the note receivable, estimated useful life of
intangible assets, deferred costs and capital assets, provisions for contingent
liabilities, measurement of stock-based compensation, valuation allowance for
future tax assets, and revenue for other product revenue using the percentage of
completion method, and reflect management’s best estimates. By their nature,
these estimates are subject to uncertainty and the effect on the financial
statements of changes in estimates in future periods could be significant.
Estimates and assumptions are reviewed periodically and the effects of revisions
are reflected in the period that they are determined to be necessary. The
allowance for doubtful accounts reflects estimates of doubtful amounts in
accounts receivable. The allowance is based on specifically identified accounts,
historical experience and other current information.
  The
Company has identified the following critical accounting policies that affect
the more significant estimates and judgments used in preparation of its
consolidated financial statements.
  **SOFTWARE
DEVELOPMENT COSTS**
  All
research and development costs are expensed as incurred except those that
qualify under the Financial Accounting Standards Board Statement (“SFAS”) No.
86, “Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed”. Research and development costs incurred prior to the
establishment of the technological feasibility of a particular software project
are expensed as incurred. Software development costs, including costs associated
with coding and testing of project related software, are capitalized subsequent
to when the technological feasibility of a project is established.
  Capitalized
costs are amortized commencing in the period of the product’s commercial
release. The determination of whether a project is technically feasible involves
establishing, at a minimum, that the Company has a detailed, documented and
consistent product and program design, including high risk development issues
related to the project, with the necessary resources to complete the project. If
a detailed program design is not used, technological feasibility will be
established when a product design or working model of the software model,
consistent with the product design, is complete and tested.
   37
  **REVENUE
RECOGNITION**
  The
Company recognizes revenue when it is earned and realized in a manner consistent
with interpretations in Staff Accounting Bulletin (“SAB”) No. 104 of the US
Securities and Exchange Commission as further described in note 2 to the
consolidated financial statements. Revenue from licensed software is recognized
in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue
Recognition”.
  Revenues
from software licensing royalties related to the sale of the product in which
the Company’s technologies have been embedded are recorded as earned. Software
licensing royalties are included in fees from licensing and
implementation.
  Under
software licensing arrangements, the Company recognizes revenues provided that:
a license agreement has been signed and fees are non-refundable; the software
and related documentation have been delivered; there are no uncertainties
regarding customer acceptance; collection of the resulting receivable is deemed
probable; the fees are fixed and determinable; and no other significant vendor
obligations exist. Any revenue associated with contracts having multiple
elements is deferred and recognized ratably over the period of the contract
unless clear evidence exists with respect to the fair value of each separate
element of the contract. Fair value for each separate element is evidenced by
existing customer contracts which stipulate rates associated with separate yet
similar services or deliverables. In addition, contracts involving significant
modifications or customization of the software sold are accounted for under the
guidelines of contract accounting.
  Customer
support revenues consist of revenue derived from contracts to provide post
contract support, such as maintenance and service support, to license holders.
The revenues are recognized ratably over the term of the contract.
  Revenue
from Oztime product contracts recorded in other product revenue is recognized
using the percentage of completion method, whereby revenue is recorded at the
estimated realizable value of work completed to date and costs incurred to date
are compared to total estimated contract costs to determine whether a loss will
be realized. Amounts received in advance are recorded as deferred revenue.
Estimated losses on contracts are recognized when they become known.
  **STOCK-BASED
COMPENSATION PLAN**
  As
permitted under SFAS No. 123, “Accounting for Stock-Based Compensation”,
regarding the accounting for the grant of employee and director stock options,
the Company has elected to use the intrinsic value method, following Accounting
Principles Board (“APB”) No. 25, “Accounting for Stock Issued to Employees”, and
related interpretations. Under APB No. 25, companies are not required to record
any compensation expense relating to the grant of options to employees or
directors where the awards are granted upon fixed terms with an exercise price
equal to fair value at the date of grant and the only condition of exercise is
continued employment. The Company accounts for restricted stock units (“RSU’s”)
in accordance with SFAS No. 123, whereby the intrinsic value method is used and
the related compensation expense is recognized over the vesting
period.
   38
  The
Company has a stock-based compensation plan, which is further described in note
9 to the Company’s consolidated financial statements. The Company has elected to
account for stock options by measuring compensation expense as the excess, if
any, of the quoted market value of the stock at the date of grant over the
exercise price. Any consideration paid by employees on exercise of stock options
or purchase of stock is credited to share capital. If stock or stock options are
repurchased from employees, the excess of the consideration paid over the
carrying amount of the stock or stock option cancelled is charged to retained
earnings.
  ***Operating
Results***
  *Discontinued
Operations*
  On
June 30, 2002, the Board of Directors of the Company approved the adoption
of a plan to dispose of its Zi Services business segment. Accordingly, the
results of operations of this business were accounted for on a discontinued
basis as at June 30, 2002. On July 1, 2002, the Company announced that
it had executed a letter of intent to sell Zi Services. On October 31,
2002, the letter of intent expired. Management determined that the carrying
value of Zi Services was no longer recoverable with certainty. As a result, in
2002 the Company recorded a provision of $2.7 million to cover
non-recoverability of costs. Combined operating losses and provision for
non-recoverable costs amounted to $5.7 million. As at December 31,
2002, the Company had sold the remaining assets of this business segment and no
longer carries on related business activities.
  *Net
Loss*
  In 2004,
the net loss was $2.4 million or $0.06 per share compared to $2.9 million or
$0.08 cents per share in the previous year. Included in the 2004 reported loss
is $2.0 million related to the impairment of a note receivable from MLG, an
approximate 44-percent owned subsidiary of the Company, and $1.4 million related
to non-cash compensation expense pertaining to the issuance of restricted stock
units to a director and officer and non-employee stock options. Excluding the
$2.0 million impairment of the MLG note receivable as described in note 3,
“Acquisitions and Dispositions” to the Company’s consolidated financial
statements and the $1.4 million non-cash compensation expense, the Company would
have recorded a profit for 2004 of approximately $1 million, a $3.4 million
improvement compared to 2003 on a similar basis. This is a non-GAAP measure
which management believes is a useful measure of performance because the
impairment charge is a non-recurring item and non-cash compensation expense was
significantly affected by a large and infrequent grant of RSU’s, rather than
reflective of the operations of the Company. The results of 2003 include
$516,000 of non-cash compensation expense. This $3.4 million reduction was
accomplished by the continued focus on the Company’s core Zi Technology business
segment with added emphasis on increasing our sales focus on markets outside of
Asia, increasing our investment in new language software databases and
controlling selling, general & administration costs (“SG&A”). Other
contributing factors to the year over year decrease in the net loss were
decreased amortization from lower remaining unamortized capital assets costs and
decreased interest expense as a result of the repayment of all outstanding debt
in July of 2004.
  In 2003,
the Company significantly reduced its net loss to $2.9 million from $25.2
million in 2002. This was accomplished by the continued focus on the Company’s
core Zi Technology business segment with added emphasis on reducing SG&A and
research and development costs. Other contributing factors to the year over year
decrease in the net loss were the absence of costs from discontinued business
segments and write-offs associated with impairment of intangible assets and
reducing litigation and judgment settlement costs as experienced in 2002.
   39
  In 2002,
the financial impact of the loss at trial under the patent infringement suit
required the Company to assess its ability to fund an appeal of the jury
verdict, as well as its other businesses and investments. Consequently, included
in the net loss of $25.2 million is provision for net losses in the aggregate
amount of $15.8 million in respect of VoIP and Bluetooth technology
business (our former Zi Services business segment) and Oztime, costs associated
with legal fees and judgment settlement costs and the loss from discontinued
operations of $5.7 million.
  *Results
from Continuing Operations*
  The
continued growth of Zi’s customer base and the increase in licensees’ products
delivered to market has resulted in an increase in revenue from our core
technology business of 30 percent to $12.9 million over 2003 revenue of $9.9
million. Revenue from all segments increased 26 percent to $13.4 million from
$10.6 million in 2003. The increase is primarily due to Zi’s growing customer
base with 81 customers contributing to revenue compared to 69 in 2003 and 57 of
these customers paying royalties in 2004 compared to 45 in 2003.
  During
2003, continued growth of Zi’s customer base and the increase in licensees’
models delivered to market resulted in an increase in revenue from our core
technology business of 53 percent to $9.9 million over 2002 revenue of $6.5
million. Revenue from all segments increased 26 percent to $10.6 million from
$8.4 million in 2002. Excluding 2002 revenue from Magic Lantern Communications
LTD (“Magic Lantern”) of $1.6 million, which was sold in November 2002, the year
over year increase is $3.8 million or 56 percent. The increase is primarily due
to Zi’s growing customer base with 69 customers contributing to revenue compared
to 47 in 2002 and 45 of these customers paying royalties in 2003 compared to 30
in 2002.
  The net
loss from continuing operations for 2004 and 2003 is as described under “Net
Loss” above.
  The net
loss from continuing operations for 2003 was $2.9 million compared to $19.5
million in 2002. Loss per share from continuing operations was $0.08 in 2003
compared to $0.52 in the prior year. This decrease was accomplished by the
continued focus on the Company’s core Zi Technology business segment with added
emphasis on reducing SG&A and research and development costs. Other
contributing factors to the year over year decrease in the net loss from
continuing operations were the absence of write-offs associated with impairment
of intangible assets and reduction of litigation and judgment settlement costs
as experienced in 2002.
  *Revenue*
  In 2004,
revenue from continuing operations rose $2.8 million to $13.4 million
or 26 percent over 2003. License and implementation fees increased
$3.0 million to $12.9 million in 2004, or 30 percent over 2003.
Other product revenue of $0.5 million relates to our e-Learning business segment
and has decreased by $0.2 million compared to 2003.
  License
and implementation fees reflect royalties earned from 57 eZiText licensees
in 2004, compared to 45 licensees in the same period a year earlier. During
2004, 406 new handset models embedded with eZiText were released into the
market, bringing the total at December 31, 2004 to 804 compared to 398 a
year earlier. The Company has increased its market penetration and is reducing
its concentration in the Asian market through our customers on new devices
introduced into the North American and European markets.
  
 40
 
 In 2003,
revenue from continuing operations rose $2.2 million to $10.6 million
or 26 percent over 2002. License and implementation fees increased
$3.4 million to $9.9 million in 2003, or 53 percent over 2002.
Other product revenue of $0.7 million relates to our e-Learning business segment
and has decreased by $1.3 million compared to 2002 due primarily to the sale of
Magic Lantern in November 2002. Adjusting 2002 other product revenue to exclude
$1.6 million related to Magic Lantern, other product revenue rose $0.4 million
or 118 percent to $0.7 million in 2003. This increase is attributable to an
increase in Oztime revenue.
  License
and implementation fees reflect royalties earned from 45 eZiText licensees
in 2003, compared to 30 licensees in the same period a year earlier. During
2003, 182 new handset models embedded with eZiText were released into the
market, bringing the total at December 31, 2003 to 398 compared to 216 a
year earlier.
  In 2002,
revenue from continuing operations rose $5.0 million to $8.4 million,
or 146 percent over 2001. License and implementation fees increased $3.2
million to $6.5 million or 99 percent over 2001. Other product
revenue, including $1.6 million from Magic Lantern, increased $1.7 million
to $1.9 million in 2002.
  License
and implementation fees reflect earned royalties from 30 eZiText licensees
in 2002, compared to 14 in the same period a year earlier. During 2002,
154 new handset models embedded with eZiText were released into the market,
bringing the total at December 31, 2002 to 216 compared to 62 a year
earlier.
  *Cost
of Sales & Gross Margin*
  In 2004,
gross margin from continuing operations increased $2.8 million to
$12.9 million, or 27 percent over the 2003 level. Cost of sales
includes the allocation of engineering expenditures associated with projects
carried out to modify existing products to meet specific customer requirements.
As a percentage of revenue from continuing operations, gross margin from
continuing operations increased to 97 percent from 96 percent in
2003.
  Gross
margin from license and implementations fees in 2004 increased to
97 percent of revenue as compared to 96 percent for 2003. This is due to
the fact that in both years more of the revenue was royalty based than services
based.
  In 2003,
gross margin from continuing operations increased $2.8 million to
$10.2 million, or 38 percent over the 2002 level. As a percentage of
revenue from continuing operations, gross margin from continuing operations
increased to 96 percent from 87 percent in 2002. Gross margin from
license and implementations fees in 2003 remained unchanged at 96 percent
of revenue from 2002
  In 2002,
gross margin from continuing operations increased $5.1 million to
$7.4 million, or 218 percent over the 2001 level. As a percentage of
revenue from continuing operations, gross margin from continuing operations
increased to 87 percent from 68 percent in 2001.
  Gross
margin from license and implementations fees in 2002 increased to
96 percent of revenue from 72 percent of revenue in 2001. This was due
to the fact that in 2002 more of the revenue was royalty based than services
based. This reflected the increased royalty-bearing eZiText implementations on
handset models penetrating the market and the fact that, implementations have a
higher cost of sales than license fees. This increase was partially offset by a
lower gross margin as a percentage of revenue attributable to Magic Lantern than
is attributed to text input software.
   41
  *Selling,
General and Administrative Expenses*
  SG&A
from continuing operations increased $1.1 million or 14 percent to
$9.3 million in 2004 over 2003. The primary reason for the increase was
non-cash compensation expense related to the issuance of RSU’s and non-employee
stock options of $1.4 million.
  SG&A
from continuing operations decreased $3.2 million or 28 percent to
$8.2 million in 2003 over 2002. The decrease is principally attributable to
the reduction of $2.2 million as a result of the sale of Magic Lantern
operations in November 2002. As well, SG&A decreased due to the continued
efforts by management to rationalize operations to effect a more competitive and
profitable structure and by concentrating resources in the Company’s core
technology business.
  SG&A
from continuing operations increased $4.8 million or 73 percent to
$11.4 million in 2002 over 2001. The increase was due to SG&A of
$2.2 million from the acquired Magic Lantern operations, severance costs
from downsizing of operations throughout 2002, higher sales commissions and
withholding taxes and allowance for potentially uncollectible customer
accounts.
  *Legal*
  Legal
costs for 2004 decreased $0.1 million to $0.8 million in 2004 compared
to 2003. The Company continues to incur costs related to ongoing patent related
work and costs for corporate securities continuous reporting
requirements.
  Legal
costs for 2003 decreased $6.6 million to $0.9 million in 2003 compared
to 2002. The decrease in legal fees is related primarily to the settlement in
2002 of the patent litigation as discussed in note 13 “Contingent
Liabilities” to the Company’s December 31, 2002 consolidated financial
statements.
  Legal
costs for 2002, as discussed in note 13 “Contingent Liabilities” to the
Company’s December 31, 2002 consolidated financial statements increased
$5.6 million to $7.5 million in 2002 over 2001.
  *Product
Research and Development Expense*
  Product
research and development expense increased to $2.4 million in 2004 from
$2.1 million in 2003. Product research and development costs relate to,
among other things, the development of new, but not yet commercialized products
and the ongoing cost of development and enhancement of products that are already
in the market and available for sale. In the year, gross expenditures on new
product development before capitalization increased $1.7 million reflecting the
Company’s focused efforts on developing dramatically new and improved language
database software. In 2004, the Company capitalized $1.7 million in software
development costs as compared to $0.2 million in 2003.
  Product
research and development expense from continuing operations decreased to
$2.1 million in 2003 from $2.8 million in 2002. In 2003, the Company
capitalized $0.2 million in software development costs as compared to $0.5
million in 2002.
   42
  In 1999,
eZiText was in the early stages of its life cycle and substantially all
development costs were deferred. In 2000, the Company continued to refine and
develop eZiText, and certain costs related to eZiText were expensed to reflect
the maintenance and upgrade nature of the expenditure. In 2001, 2002, 2003 and
2004 this trend continued.
  In the
Oztime business unit, all of the product research and development costs prior to
2001 were expensed. In 2001, Oztime achieved the critical milestone of proving
technical feasibility and commercial viability through customer acceptance of
its technology and commenced deferral of product development costs. At
September 30, 2002, as a result of the unfavourable litigation outcome, the
Company determined that recovery of these costs was uncertain and recorded a
$1.5 million provision for impairment of all capitalized costs within
Oztime.
  Product
research and development expense from continuing operations rose to
$2.8 million in 2002 from $0.6 million in 2001.
  *Depreciation
and Amortization*
  Depreciation
and amortization from continuing operations decreased in 2004 by
$0.5 million or 33 percent to $0.9 million from $1.4 million
in 2003. The decrease is due to the decrease in remaining unamortized eZiText
related capitalized software development costs and decreased depreciation
related to unamortized leasehold improvements.
  Depreciation
and amortization from continuing operations decreased in 2003 by
$0.8 million or 38 percent to $1.4 million from $2.2 million
in 2002. The decrease is due to the lower remaining unamortized eZiText related
capitalized software development costs and decreased depreciation related to
unamortized leasehold improvements. In 2002, depreciation and amortization from
continuing operations was $2.2 million, an increase of $0.1 million or
4 percent from the $2.1 million in 2001.
  *Impairment
of Note Receivable*
  At
December 31, 2004, the Company evaluated its $2.0 million note receivable from
its 44 percent owned MLG for impairment and determined that subject to SFAS No.
114 “Accounting by Creditors for Impairment of Loan” using a projected
discounted cash flow model at the loan’s effective interest rate, the full
amount of the note receivable including accrued interest was impaired and a
provision warranted. MLG is currently subject to a going concern qualification
and subject to its ongoing operating cash requirements, continued operating
losses and other debt, to which the Company is subordinate. Due to these factors
and the absence of private placements originally anticipated to occur by MLG in
the fourth quarter of 2004, it is probable that MLG will not have the necessary
funds available to meet the requirements under the note, including payment of
accrued interest.
  *Impairment
of Goodwill*
  In 2002,
as a result of the unfavourable litigation outcome, the Company determined that
recovery of goodwill related to Oztime was uncertain and recorded an impairment
charge of $1.3 million as described in note 6, “Intangible Assets” to the
Company’s consolidated financial statements.
  **
 43
 **
 *Impairment
of Intangible Assets*
  In 2002,
as a result of the unfavourable litigation outcome, the Company determined that
the recovery of capitalized software development costs related to Oztime was
uncertain and recorded an impairment charge of $1.5 million as described in
note 6, “Intangible Assets” to the Company’s consolidated financial
statements.
  *Interest
and Other Income*
  Interest
and other income increased to $0.1 million in 2004 from $23,483 in 2003 as
the Company’s cash position improved from minimal cash and periods of
indebtedness throughout most of 2003 to a cash position of $12.9 million at
December 31, 2004. The Company has completed a CDN$10 million private placement
in July 2004 and generated positive cash inflow for the year of $0.9
million.
  The
reduction in interest income to $23,483 in 2003 from $0.2 million in 2002
is due to the Company’s overall indebtedness throughout most of 2003. Cash
resources were used to meet ongoing operating cash usage requirements and to
repay outstanding debt obligations.
  The
reduction in interest income to $0.2 million in 2002 from $1.0 million
in 2001 was due to lower interest rates on lower cash balances. In 2002,
interest rates earned on funds on deposit and other liquid investments ranged
between one and three percent.
  *Interest
Expense*
  Other
interest expense decreased $0.6 million to $30,839 reflecting repayment of the
$1.0 million demand credit facility in July 2004 from the proceeds of a private
placement. In 2003, other interest expense included interest paid and financing
fees amortized on a note payable of $3.3 million until its refinancing on May 7,
2003 and on $1.9 million until June 20, 2003 after which it was repaid. Interest
on long-term debt from continuing operations in 2004 represents interest on
capital lease obligations. These obligations relate to the purchase of computer
and communications equipment.
  Other
interest expense increased $0.5 million to $0.6 million reflecting interest paid
and financing fees amortized on a note payable of $3.3 million until its
refinancing on May 7, 2003 and on $1.9 million until June 20, 2003 after which
it was repaid. Interest on long-term debt from continuing operations in 2003
represents interest on capital lease obligations.
  Interest
on long-term debt from continuing operations in 2002 included $67,961 of
interest on debt owed by Magic Lantern. In 2002, other interest expense from
continuing operations included the amortized portion of a deferred financing
cost of $0.3 million and interest expense both related to a note payable of
$3.3 million outstanding at December 31, 2002.
  *Income
Tax Expense*
  As an
international company subject to income tax rates in different countries, Zi’s
consolidated effective tax rate is the blend of varying rates on pre-tax profits
and losses in several tax jurisdictions. Utilization of previous years’ tax loss
carryforwards, changes in income sources and applicable rates result in
fluctuations in the effective tax rate. In 2004, 2003 and 2002, Zi incurred
losses for tax purposes, the benefit of which has not been reflected in these
financial statements. A valuation allowance equivalent to the full value of the
future tax assets of $19.0 million is reflected in the consolidated financial
statements.
   44
  Zi has
tax loss carryforwards of approximately $77.7 million, which can be applied
against future years’ taxable income in their respective jurisdictions. Taxable
income earned by Zi’s foreign subsidiaries is subject to the Canadian foreign
affiliate rules. For Canadian companies, there is no additional Canadian income
tax on repatriated profits from active business operations in countries with
which Canada has a tax treaty.
  *Net
Loss from Continuing Operations*
  Zi’s net
loss from continuing operations decreased to $2.4 million in 2004 from $2.9
million in 2003. The decrease in the net loss of $0.5 million was due
to:
  §
    $0.5 million
      decrease in depreciation and amortization;
 §
    $0.5
      million decrease in interest expense;
 §
    $0.1
      million increase in interest and other income, and;
 §
    $2.8 million
      increase in gross margin, offset by;
 §
    $1.1 million
      increase in SG&A;
 §
    $0.3
      increase in product research and development expense,
  and;
 §
    $2.0
      impairment of note receivable.
 
 Zi’s net
loss from continuing operations decreased to $2.9 million in 2003 from
$19.5 million in 2002. The decrease in loss of $16.6 million was due
to:
  §
    $3.2 million
      increase in SG&A costs;
 §
    $0.7 million
      increase in product research and development
expense;
 §
    $6.6
      million decrease related to legal
expenditures;
 §
    $0.9 million
      increase in depreciation and amortization;
 §
    $1.3 million
      decrease due to no impairment of goodwill
charge;
 §
    $1.5 million
      decrease due to no impairment of intangible assets
  charge;
 §
    $0.2
      million decrease due to no loss from equity of significantly influenced
      company, and;
 §
    $2.8 million
      increase in gross margin, offset by;
 §
    $0.4 million
      increase in interest expense, and;
 §
    $0.2 million
      decrease in interest income.
 
 Zi’s net
loss from continuing operations increased to $19.5 million in 2002 from
$8.1 million in 2001. The increase in loss of $11.6 million was due
to:
  §
    $4.8 million
      increase in SG&A costs, which included $2.2 million as a result
      of the acquisition of MLG operations;
 §
    $5.6 million
      increase related to legal expenditures;
 §
    $2.2 million
      increase in product research and development
expense;
 §
    $1.3 million
      impairment of goodwill charge;
 §
    $1.5 million
      impairment of intangible assets charge;
 §
    $0.8 million
      decline in interest income, and;
 §
    $0.2
      million equity in net loss of significantly influenced company, offset
      by;
 §
    $5.1 million
      increase in gross margin, and;
 §
    $0.1
      million decrease in income taxes.
 
  45
 
 *Impact
of Inflation and Changing Prices*
  Inflation
is not a major factor affecting continuing operations.
  *Foreign
Currency*
  All
non-US operations of the Company are translated into US dollars for financial
statement presentation. Consequently, movements in exchange rates may have a
significant impact on financial results. Substantially all of the Company’s
product revenues are denominated in US dollars while a significant portion of
expenses are denominated in Canadian dollars and US dollars, and to a lesser
extent Hong Kong dollars, Swedish Kronas, Pounds Sterling and Chinese Renminbi.
Based on the 2004 distribution of revenues and cash flows, a one percent change
in the Canadian dollar relative to the US dollar is estimated to affect revenues
by $nil and expenses by $65,000.
  *Impact
of Governmental Policies and Other Factors on Operations and
Investments*
  Zi
Corporation operates primarily in Canada, the United States of America, China
and Hong Kong. The market for the Company’s products includes all of the
developed and many of the less developed countries in the world. Accordingly
changes in governmental trade, fiscal and other policies could have an impact on
sales and on the ability of the Company to transfer funds and/or manage foreign
operations.
  ***B.*** ***Liquidity
and Capital Resources***
  *Financial
Condition and Liquidity*
  At
December 31, 2004 Zi had cash and cash equivalents of $12.9 million.
The objective of Zi’s investment policy for funds is to preserve capital and
maintain short-term liquidity while earning reasonable investment
returns.
  At
December 31, 2003 Zi had cash and cash equivalents of $2.4 million. At
December 31, 2002, Zi had cash, cash equivalents and short-term investments
of $3.4 million.
  *Cash
Requirements Outlook*
  During
the past three years, the Company’s cash requirements have been met through
revenues from operations, private placements of common shares and warrants and
the exercise of common share purchase warrants and options.
  Net cash
generated by the Company in 2004 was $0.9 million. Cash generated from
operations was a result of increasing sales revenue while maintaining SG&A
levels, investing in new product development and repayment of all outstanding
debt.
  Net cash
utilized by the Company in 2003 was $1.3 million. The principal uses of
funds were to pay instalments due under a litigation settlement and fund the
e-Learning business segment.
  
 46
  Capital
requirements in 2005 include costs to carry Oztime until its divestiture and
funding of continued new product development and enhancements to existing
products.
  At
current revenue and expense levels, the Company is able to fund its continued
operations and meets its current obligations.
  On
December 19, 2003, the Company borrowed $1.0 million through the issuance of a
demand loan payable. The note payable bore interest at the prime rate (4.5
percent at December 31, 2003) plus one percent payable monthly. The facility is
secured by a first security interest in 5,000,000 shares of MLG, held by the
Company. On July 20, 2004, the Company repaid this loan.
  On
December 6, 2002, the Company settled a judgment in favour of AOL, as
discussed in note 13, “Contingent Liabilities” to the Company’s
December 31, 2002 consolidated financial statements. Under the terms of the
settlement agreement, the Company paid, among other things, a remaining
$0.75 million on January 2, 2004.
   *Operating
Activities*
  Cash
generated from operations in 2004 was $0.9 million as compared to cash
applied to operations of $1.3 million in 2003. The $2.2 million year
over year increase in cash flow from operations was due to the $2.4 million net
loss, adjusted for non-cash items of $4.3 million offset by an increase of
$0.6 million of non-cash working capital.
  In 2004,
non-cash working capital used $1.0 million in cash. This was due to the
decrease in accounts payable at December 31, 2004 of $1.0 million and
the increase in accounts receivable by $1.6 million partially offset by an
increase in deferred revenue of $1.6 million. The decrease in accounts payable
relates to payment of accrued settlement costs and the increase in accounts
receivable relates to the signing of a significant customer contract in the
fourth quarter of 2004. Other license and implementation revenue remained
constant year over year.
  Cash
applied to operations in 2003 decreased to $1.3 million from
$13.0 million in 2002. The $11.7 million year over year decrease in
cash applied to operations was due to the decrease in net loss, adjusted for
non-cash items of $13.3 million offset by an increase of $1.6 million
of non-cash working capital.
  In 2003,
non-cash working capital used $0.4 million in cash. This was due to the
decrease in accounts payable at December 31, 2003 of $0.2 million and
increase in accounts receivable by $1.2 partially offset by an increase in
deferred revenue of $0.6 million and a decrease in work in process and prepaid
expenses of $0.3 million. The decrease in accounts payable relates to payment of
accrued settlement and representation costs, the increase in accounts receivable
relates to a higher volume of revenue in the fourth quarter of 2003 over the
same quarter of the prior year.
  Cash
applied to operations in 2002 increased to $13.0 million from
$5.1 million in 2001. The $7.9 million year over year increase in cash
applied to operations was due to the increase in net loss, adjusted for non-cash
items of $8.2 million and offset by $0.3 million of cash generated
from non-cash working capital.
  
 47
 
 In 2002,
non-cash working capital generated $1.2 million in cash. This was due to
the increase in accounts payable at December 31, 2002 of $2.3 million
partially offset by an increase in accounts receivable of $1.1 million. The
increase in accounts payable relates to accrued settlement and representation
costs, the increase in accounts receivable relates to a higher volume of revenue
in the fourth quarter of 2002 over the same quarter of the prior
year.
  *Financing
Activities*
  The
Company has financed its operating and investing activities during the last
three years principally as follows:
  **Year**
    
    **Method
      of financing**
    
    **Amount**2004
    
    issuance
      of common shares pursuant to a private placement and exercise of stock
      options
      settlement
      of notes payable
    
    $
      12.2 million
      $
      (1.0) million2003
    
    issuance
      of common shares pursuant to a private placement and exercise of stock
      options
      issuance
      of demand note payable
      settlement
      of notes payable
    
    $
      2.9 million
      $
      1.0 million
      $
      (3.3) million2002
    
    issuance
      of common shares pursuant to exercise of stock options
      issuance
      of demand note payable
    
    $
      0.7 million
      $
      3.3 million
 
 
 *Investing
Activities*
  In 2004,
cash used in investing activities was $1.9 million, as compared to
$0.4 million in 2003.
  In 2003,
cash used in investing activities was $0.4 million, as compared to $2.7
million of cash generated from investing activities in 2002. Adjusted for
short-term investments, this balance decreased $5.4 million to 2.7 million of
cash used in investing activities in 2002.
  In 2002,
cash generated from investing activities was $2.7 million, as compared to
$8.2 million used in investing activities in 2001. Adjusted for short-term
investments, cash used in investing activities was $2.7 million in 2002
compared to $2.8 million in the prior year.
  The
increase of $1.5 million in 2004 over 2003 of cash used in investing
activities is due to the Company’s focused efforts on developing dramatically
new and improved language database software in 2004. In 2004, the Company
capitalized $1.7 million in software development costs as compared to $0.2
million in 2003.
  The
decrease of $2.3 million in 2003 over 2002 cash used in investing
activities after adjusting for short-term investments, is due to no acquisitions
or dispositions of subsidiaries’ related activity in 2003 and decreased
investment in software development and capital assets as compared to 2002
activity.
  The
decrease of $0.1 million in 2002 over 2001 cash used in investing
activities is due to a $1.5 million increase in acquisitions and
dispositions of subsidiaries and a $0.4 million increase in the purchase of
capital assets, offset by a $2.0 million decrease in software development
costs and $0.1 million increase in other long-term liabilities.
  
 48
  **
 *Commitments
and Contractual Obligations*
  At
December 31, 2004, Zi has no long-term debt or long-term liabilities other
than capital lease obligations and deferred inducements received upon entering
into new office leases. During 2004, 2003 and 2002, we entered into leases for
computer equipment with payment terms over three years. The obligation,
including the current portion, totalled $29,059 at December 31, 2004. See
Item 6 for contractual obligation disclosure related to employee compensation.
The future minimum lease payments under the capital leases are as
follows:
  2005
    
    $
    19,1972006
    
    
    8,0492007
    
    
    1,813Total
      minimum lease payments
    
    
    29,059Amount
      representing interest
    
    
    3,540Amount
      included in current liabilities
    
    
    16,445$
    9,074
 
 **
 *Financial
Instruments*
  At
December 31, 2004, Zi had cash and cash equivalents of $12.9 million.
Surplus funds are held primarily in US dollars and are converted into Canadian
dollars, Hong Kong dollars and Chinese renminbi as required by the head office
and operating divisions in those countries. The Controller, in consultation with
the Chief Financial Officer and within the objectives of the Company’s
investment guidelines, is responsible for the day-to-day management of surplus
funds. The objectives of Zi’s investment policy for surplus funds are to
preserve capital and maintain short-term liquidity while earning reasonable
investment returns.
  Zi has
not entered into any arrangements to hedge its foreign exchange requirements or
its foreign assets.
  *Off-Balance
Sheet Arrangements*
  The
Company has no off-balance sheet arrangements
  ***C.*** ***Research
and Development, Patents and Licenses, etc*** **.**
  The
Company’s intellectual property may be grouped into the following product areas:
eZiText, and educational products and corporate materials. It includes patents,
copyrights, trademarks, domain names and trade secrets (people, technical
know-how and documents). Historically most of Zi’s research and development
activity was dedicated to text input technology.
   49
  Research
costs are expensed as incurred. Development costs incurred prior to the
establishment of the technological and financial feasibility of a project are
expensed as incurred. Software development costs, including costs associated
with coding and testing of project related software, are capitalized subsequent
to when the technological feasibility of a project is established. Capitalized
costs are amortized commencing in the period of the products’ commercial release
using the straight-line method over the related product’s estimated economic
life.
  Due to
the nature of Zi’s acquired intellectual property, values have not been
specifically assigned to patents, licenses, domain names, etc. acquired prior to
2001, and are generally classified as “goodwill”.
  Expenditures
for product research and development costs, including deferred amounts
(including the former Zi Services business unit) and for acquired IP during the
past three years are as follows:
  **R &
      D($000’s)**
    
    **Goodwill**2004
    
    $
    4,012
    
    
    nil2003
    
    $
    2,336
    
    
    nil2002
    
    $
    4,493
    
    
    nil
 
 Research
and development expenditures will depend upon our available capital resources
during the year ending December 31, 2005, and will primarily relate to our
research and development efforts on our eZiText and Qix technology. We may also
expend additional resources on research and development of related or
complementary technologies, including our recently purchased patents relating to
handwriting recognition (see note 19 “Subsequent Events” to the Company’s
consolidated financial statements).
   50
  ***D.*** ***Trend
Information***
  *Revenues
and Expenses*
  For the
years ended December 31, 2002, 2003 and 2004 our revenue by geographical
market and category consisted of:
  
  **Revenue****(3)****License
      and implementationfees**
    
    **Software
      andother**
    
    **Total****2004**
    
    
    Canada(1
    )
    **$**
    **5,884,396**
    
    **$**
    **8,120**
    
    **$**
    **5,892,516**China
    
    
    **5,207,579**
    
    
    **496,093**
    
    
    **5,703,672**USA(2
    )
    
    **1,806,863**
    
    
    —
    
    
    **1,806,863**Total
    
    **$**
    **12,898,838**
    
    **$**
    **504,213**
    
    **$**
    **13,403,051**2003
    
    
    Canada(1
    )
    $
    3,731,859
    
    $
    13,982
    
    $
    3,745,841China
    
    
    3,378,770
    
    
    670,088
    
    
    4,048,858USA(2
    )
    
    2,808,369
    
    
    —
    
    
    2,808,369Total
    
    $
    9,918,998
    
    $
    684,070
    
    $
    10,603,0682002
    
    
    Canada(1
    )
    $
    2,315,344
    
    $
    1,638,898
    
    $
    3,954,242China
    
    
    1,368,614
    
    
    296,411
    
    
    1,665,025USA(2
    )
    
    2,796,980
    
    
    —
    
    
    2,796,980Total
    
    $
    6,480,938
    
    $
    ,935,309
    
    $
    8,416,247
 Notes:
  (1)
    The
      actual geographic markets for the products licensed under licensing
      agreements between OEMs and Zi Corporation of Canada, Inc. are in Asia,
      North America and Europe.
 
 (2)
    The actual geographic markets for products licensed under
      licensing agreements between OEMs and Zi Corporation of America, Inc. are
      in Asia and the United States.
 
 (3)
    The
      Company discontinued the operations of its Zi Services business unit in
      December 2002. Revenues of Zi Services for 2002 were $153,030. All Zi
      Services revenues would be included in China’s geographical
      segment.
  The
continued growth of Zi’s customer base and the increase in licensees’ models
delivered to market has resulted in an increase in revenue from our core
technology business of 30 percent to $12.9 million over 2003 revenue of $9.9
million. Revenue from all segments increased 26 percent to $13.4 million from
$10.6 million in 2003. The increase is primarily due to Zi’s growing customer
base with 81 customers contributing to revenue compared to 69 in 2003 and 57 of
these customers paying royalties in 2004 compared to 45 in 2003.  For 2003,
the growth in commercialization of Zi’s technology in its core eZiText® related
business generated a 53 percent increase in revenue over that in 2002.
License and implementation fees increased $3.4 million to $9.9 million in
2003. The increase is primarily due to Zi’s growing customer base with 69
customers contributing to revenue compared to 47 in 2002 and 45 of these
customers paying royalties in 2003 compared to 30 in
2002.
 
 
 51
 
 Zi’s
technology generated a 146 percent increase in revenue from continuing
operations in 2002 over that in 2001. License and implementation fees increased
$3.2 million to $6.5 million in 2002, or 99 percent over 2001.
The increase is due primarily to the increase in size of our eZiText customer
base through increased global demand, with 47 licensees contributing to
revenue in 2002, compared to 34 licensees in 2001 and 30 of these customers
paying royalties in 2002 compared to 14 in 2001. We expect that customer
applications will to continue to increase through the growth in global demand
but be partially offset by an industry wide trend of decreasing per unit royalty
amounts.
  Our
revenue comes from our OEM customers. The majority of our OEM customers’
products, which have implemented our eZiText product resulting in
royalty-bearing eZiText enabled products, have been sold in Asia and Europe. A
number of our new OEM customers’ and existing OEM customers’ products are now
being sold outside of Asia including the North American market. As more of our
customers’ products enter the marketplace, we anticipate this trend to continue
with respect to our eZiText product line. The Company’s revenues are expected to
include revenue from the Decuma handwriting recognition software and the launch
of Zi’s Qix user application interface product. The growth in revenues related
to these new product lines is dependant on their integration with existing
products and market acceptance.
  In 2004,
gross margin from continuing operations increased $2.8 million to
$12.9 million, or 27 percent over the 2003 level. Cost of sales
includes the allocation of research and development expenditures associated with
projects carried out to modify existing products to meet specific customer
requirements. As a percentage of revenue from continuing operations, gross
margin from continuing operations increased to 97 percent from
96 percent in 2003. Gross margin from license and implementations fees in
2004 increased to 97 percent of revenue as compared to 96 percent for 2003.
This is due to the fact that in both years more of the revenue was royalty based
as opposed to services based. This reflects the increased royalty-generating
eZiText implementations on handset models now penetrating the market and the
fact that, implementations have a higher cost of sales than royalties generated
through our licensees. The Company anticipates this trend to continue with
respect to our eZiText product line. As the new products, Decuma handwriting
recognition software and Qix will also be royalty based, we expect the trend of
a high gross margin related to sales to continue.
  SG&A
from continuing operations increased $1.1 million or 14 percent to
$9.3 million in 2004 over 2003. Adjusting for non-cash compensation expense
related to the issuance of restricted stock units and non-employee stock options
of $1.4 million, SG&A increased $0.3 million. This small increase is due to
the continued efforts by management to rationalize operations to effect a more
competitive and profitable structure and by concentrating resources in the
Company’s core technology business.
  SG&A
from continuing operations decreased $3.2 million or 28 percent to
$8.1 million in 2003 over 2002. The decrease is partially attributable to
the reduction of $2.1 million realized through the disposal of MLG
operations in November 2002. As well, SG&A decreased due to the continued
efforts by management to rationalize operations to affect a more competitive and
profitable structure and by concentrating resources in the Company’s core
technology business.
  
 
  Prior to
2003, our SG&A costs had increased year over year for the prior
three years. SG&A from continuing operations increased
$4.8 million or 73 percent to $11.4 million in 2002 over 2001.
The increase is partially attributable to SG&A of $2.1 million from the
acquired Magic Lantern operations. As well, SG&A increased due to severance
costs from downsizing of operations throughout 2002, higher sales commissions
and withholding taxes and allowance for potentially uncollectible customer
accounts
  As a
result of the reductions that we have made in SG&A costs, we anticipate that
the Company will continue to keep these costs at or near current year levels. Zi
now has an SG&A cost base that will support further revenue growth without
significant expense increases. This means that even though we may need to invest
additional resources at times to meet specific revenue opportunities, as we
generate incremental revenue it will have an increasingly positive impact on
future operating results. The acquisition of Decuma AB’s handwriting recognition
and the associated operating costs of running a Swedish subsidiary will add to
SG&A costs in 2005 but as this products acceptance in the market and its
integration into Zi’s other product lines is complete, we expect revenue growth
from new and existing customers.
  Product
research and development expense from continuing operations increased to
$2.4 million in 2004 from $2.1 million in 2003. In the year, gross
expenditures on new product development before capitalization increased $1.7
million reflecting the Company’s focused efforts on developing dramatically new
and improved language database software. In 2004, the Company capitalized $1.7
million in software development costs as compared to $0.2 million in
2003.
  Product
research and development expense from continuing operations decreased to
$2.1 million in 2003 from $2.8 million in 2002. Prior to 2003, our
product research and development expenses had increased over the prior three
years. As eZiText matures, we anticipate continued investment into developing
enhanced and related new technologies and new language database software given
the availability of capital required to finance further those product research
and development activities. We will continue to invest in our new products,
including handwriting recognition and Qix. We anticipate that our research and
development spending will moderately increase over the 2004 level depending on
the availability of capital and resources required by specific revenue
generating opportunities.
  Depreciation
and amortization from continuing operations decreased in 2004 by
$0.5 million or 33 percent to $0.9 million from $1.4 million
in 2003. The decrease is due to the decrease in remaining unamortized eZiText
related capitalized software development costs and decreased depreciation
related to unamortized leasehold improvements. Depreciation and amortization
from continuing operations decreased in 2003 by $0.8 million or
38 percent to $1.4 million from $2.2 million in 2002. The
decrease is due to lower remaining unamortized eZiText related capitalized
software development costs and decreased depreciation related to decreased
unamortized leasehold improvements. Prior to 2003, depreciation and amortization
from continuing operations increased in 2002 by $0.1 million or
4 percent to $2.2 million from $2.1 million in 2001. Given the
increase in capitalized software development costs and capital assets, we
anticipate that our depreciation and amortization expense will increase
moderately in 2005.
  
 In 2004,
the Company significantly reduced its net loss to $0.4 million, after adjusting
for the $2.0 million impairment of the MLG note receivable, from $2.9 million in
2003. This was accomplished by the continued focus on the Company’s core Zi
Technology business segment with added emphasis on increasing our sales focus on
markets outside of Asia, increasing our investment in new language software
databases and holding SG&A at its prior year level. Other contributing
factors to the year over year decrease in the net loss were decreased
amortization from lower remaining unamortized capital assets costs and decreased
interest expense as a result of the repayment of all outstanding debt in July of
2004. In 2003, the Company significantly reduced its net loss to $2.9 million
from $25.2 million in 2002. This was accomplished by the continued focus on the
Company’s core Zi Technology business segment with added emphasis on reducing
SG&A and research and development costs. For the three years prior to 2003,
our net loss had increased year over year.
   53
  Litigation/Indemnification
  There has
been no determination of whether we will be required to indemnify Alcatel and
Ericsson with respect to patent infringement claims against them. Both patent
infringement claims allege they are related to our eZiText technology, our
principal product. In 2004, we derived approximately 6 percent of our total
revenues from our licenses with Ericsson and Alcatel. In the event our
technology is found to infringe on the patents of others in these legal
proceedings, the Company would have to defend itself under the indemnification
provisions of the licence agreements.
  We have
also undertaken considerable expense in actively protecting our intellectual
property and defending against alleged infringement claims by Tegic
Communications Inc. (“Tegic”). We have incurred substantial costs related to
patent infringement litigation in the sum of $60,000 for 2004 (2003 - $289,000;
2002 - $6.9 million of which approximately $4.5 million was for settlement
costs) for defense and settlement of such claims.
  On
December 4, 2003, the Company commenced action against Morrison & Foerster
LLP (“MoFo”) in the Superior Court of the State of California, County of San
Francisco claiming (i) professional negligence based on MoFo's failure to
exercise reasonable care, skill and diligence in representing the Company in the
defence of Asian Communication Pty Ltd and Tegic Communications Inc. (“Tegic”)
v. Zi Corporation and Zi Corporation of America, Inc. (a patent infringement
lawsuit) and (ii) reimbursement of the payments made to MoFo in connection with
the defense of this lawsuit, which payments are alleged to exceed the reasonable
value of MoFo's services and costs advanced. MoFo has filed, as part of its
defence to the Company's action, a cross complaint against the Company for
unpaid legal fees and costs. Although the Company believes that it will prevail
in this action, in 2002, the Company accrued $1,061,617 in the consolidated
financial statements representing the previously billed fees and costs.
Accordingly, the Company believes that any further exposure from this action is
limited to accrued interest and costs.
  The
$9.0 million damages judgement awarded to Tegic was settled pursuant to a
written settlement agreement with AOL dated December 6, 2002 and a consent
judgement dated December 20, 2002. Settlement costs were included as part
of legal and litigation costs as at December 31, 2002, including the final
scheduled instalment of $0.75 million, which was paid on January 2,
2004.
  From time
to time, the Company is involved in other claims in the normal course of
business. Management assesses such claims and where considered likely to result
in a material exposure and where the amount of the claim is quantifiable,
provisions for loss are made based on management’s assessment of the probable
outcome. The Company does not provide for claims that are not probable to result
in a significant loss, claims for which the outcome is not determinable or
claims where the amount of the loss cannot be reasonably estimated. Any
settlements or awards under such claims are provided for when reasonably
determinable.
   54
  Although
we do not anticipate or foresee at this time any new intellectual property
proceedings being instigated by other parties against us or by us against other
parties, there is no assurance that our legal costs or legal actions will
significantly diminish in the future. We do not view the legal expenses on the
current legal actions and indemnities as being of a recurring nature and
anticipate that these legal matters will eventually come to a resolution;
however, our legal costs in respect of these actions may increase or maintain
current levels if any judgement or determination is appealed or otherwise
progresses though the legal process. Moreover, given the extremely competitive
nature of our eZiText business and the wide scope of intellectual property
covering the text input space, there can be no assurance that in the future, we,
or any of our licensees, will not be continually subject to allegations
concerning the status or validity of our intellectual property.
  **E.** **Off-Balance
Sheet Arrangement**
  The
Company did not have any off—balance sheet arrangements at December 31,
2004.
  **F.** **Tabular
Disclosure of Contractual Obligations**
  Zi has no
long-term debt or long-term liabilities other than capital lease obligations at
December 31, 2004. During 2004, 2003 and 2002, we entered into leases for
computer equipment with payment terms over three years. The obligation,
including the current portion, totalled $29,059 at December 31, 2004. The
future minimum lease payments under the capital leases are as
follows:
  2005
    
    $
    19,1972006
    
    
    8,0492007
    
    
    1,813Total
      minimum lease payments
    
    
    29,059Amount
      representing interest
    
    
    3,539Amount
      included in current liabilities
    
    
    16,445$
    9,075
 
 
 See Item
6 for contractual obligation disclosure related to employees.
  The
Company rents premises and equipment under operating leases, which expire at
various dates up to June 2007. Annual rentals under these leases for each of the
next five years are as follows:
 
  55
   2005
    
    $
    618,6802006
    
    
    538,4072007
    
    
    194,7112008
    
    
    —2009
    
    
    —Total
    
    $
    1,351,798
 
  From time
to time the Company enters into certain types of contracts that require it to
indemnify parties against possible third party claims particularly when these
contracts relate to licensing agreements. On occasion the Company may provide
indemnities. The terms of such obligations vary and generally, a maximum is not
explicitly stated. Because the financial obligations in these agreements are
often not explicitly stated, the overall maximum amount of the obligations
cannot be reasonably estimated. Historically, the Company has not been obligated
to make significant payments for these indemnification obligations. The
Company’s management actively monitors the Company’s exposure to the above risks
and obtains insurance coverage to satisfy potential or future claims as
necessary.
 
 G. Safe
Harbour
  Not
applicable.
  **Item 6**  **Directors,
Senior Management and Employees**
  ***A.*** ***Directors
and Senior Management***
  Each
director is generally elected by a vote at the annual meeting of shareholders in
service for a term of one year. Each executive officer will serve until his/her
successor is elected or appointed by the Board of Directors or his/her earlier
removal or resignation from office. There are no family relationships between
any of our executive officers and our directors. The following table lists the
directors and senior management of the Company together with their respective
positions as of March 23, 2005:
 
 
 56
   **Name**
    
    **Position
      or office within Corporation**Michael
      E. Lobsinger
      Calgary,
      Alberta, Canada
    
    Chairman
      of the Board and DirectorDerrick
      R. Armstrong(3)
      Calgary,
      Alberta, Canada
    
    Director
      and
      Corporate
      SecretaryThompson
      MacDonald(1)(3)
      Calgary,
      Alberta, Canada
    
    DirectorAngus
      Michael Roderick Mackenzie(1)(2)
      Englefield
      Green, Surrey, U.K.
    
    DirectorHoward
      R. Balloch(3)
      Beijing,
      China
    
    DirectorChairman,
      Oztime
      SubsidiaryH. Donald
      Hyde(1)(2)
      Calgary,
      Alberta, Canada
    
    DirectorDonald
      Moore
      Miami,
      Florida, U.S.A.
    
    DirectorRichard
      Tingle
      Calgary,
      Alberta, Canada
    
    DirectorMike
      D. Donnell
      Denver,
      Colorado, U.S.A.
    
    President
      and Chief Executive OfficerDale
      Kearns
      Calgary,
      Alberta, Canada
    
    Chief
      Financial OfficerMilos
      Djokovic
      Denver,
      Colorado, U.S.A.
    
    Chief
      Operating Officer and Chief Technology OfficerGlen
      Morgan
      Dallas,
      Texas, U.S.A.
    
    Senior
      Vice President, Global Sales and Marketing
 **Note** **s:**
  (1)Member
of the Audit Committee during 2004.
 (2)Member
of the Compensation Committee during 2004.
 (3)Member
of the Corporate Governance Committee during 2004.
  MICHAEL E.
LOBSINGER was the chief executive officer of the Company from 1993 to November,
2003 and President of the Company from 1993 to 2000. Mr. Lobsinger has been
a director of the Company since 1987. Prior to joining the Company,
Mr. Lobsinger was an entrepreneur with experience in real estate
development and the oil and gas industry. Effective November 19, 2003, Mr.
Lobsinger and the Company agreed that the positions of Chairman of the Board and
Chief Executive Officer would be separated, such that Mr. Lobsinger would no
longer be Chief Executive Officer of the Company but would remain Chairman of
the Board.
  DERRICK R.
ARMSTRONG has been a director and secretary of the Company since 1993.
Mr. Armstrong is a lawyer and partner with Borden Ladner Gervais LLP,
Barristers & Solicitors, practicing primarily in securities and
corporate commercial law. Mr. Armstrong is also a director of Veteran
Resources Inc., and Centurion Energy International Inc., both publicly traded
resource companies.
  THOMPSON
MACDONALD has been a director of the Company since 1993. Mr. MacDonald is a
Communications Consultant and has run his own consulting practice since
1988.
  ANGUS
MICHAEL R. MACKENZIE was elected as a director at the Company’s annual
general meeting held in June, 2001. Mr. Mackenzie has been the Director
General and Managing Partner of Champagne Jacquesson & Fils, Dizy,
France since 1998. Mr. Mackenzie was the Director of Jefferies Pacific
Limited, Hong Kong, from 1994 to 1997 and is the Chairman of Mayfair Cellars
Group, London and of Tasmanian Vineyards Pty. Mr. Mackenzie has served as
director of three of our Bermuda subsidiaries since July 2000 and as director of
Magic Lantern Group, Inc., a distributor of educational media that is traded on
the American Stock Exchange, since November 2002. He is also a Director of The
Lindsell Train Investment Trust PLC since 2000.
   57
  HOWARD R.
BALLOCH was elected as a director on August 4, 2001. Mr. Balloch
served as Canada’s Ambassador to China for more than five years, retiring
from the Canadian Foreign Service in August, 2001.. Mr. Balloch was
appointed a director of Magic Lantern Group, Inc. in November 2002.
  H. DONALD
HYDE was elected as a director at the Company’s annual general meeting held in
June 2003 and is currently the chair of the Audit Committee and serves on the
Compensation Committee. Mr. Hyde is a chartered accountant and has had his own
practice since 1991. Prior to setting up his own practice, Mr. Hyde was the vice
president of finance and administration for an international oil and gas
drilling and service company. Mr. Hyde was appointed to the Board of Magic
Lantern Group, Inc. in November 2004.
  DONALD
MOORE was elected to the Board pursuant to an agreement between the Company and
the receiver for the Lancer group of funds dated July 15, 2004. The
Agreement was entered into in consideration for the Lancer Group of Funds
entering into an undertaking that restricted their ability to trade shares of
the Company for a period of time (that has since expired), given to an agent
under an offering of securities by the Company that closed in July, 2004. Mr.
Moore is a lawyer in the Miami office of Fowler White Burnett P.A.
  RICHARD
TINGLE, Q.C. was elected to the Board in January 2005. Since 1992 Mr. Tingle is
a lawyer with Tingle Merret LLP (formerly Tingle & Associates).
  MIKE D.
DONNELL was named President and Chief Operating Officer of the Company on July
25, 2003 and was appointed as Chief Executive Officer on November 19, 2003. Mr.
Donnell is a veteran of the telecommunications industry with eighteen years of
experience. Prior to joining Zi, Mr. Donnell held senior positions with such
companies as Cellular One, San Francisco where he was the chief executive
officer and PageNet where he was the president.
  DALE
KEARNS has been the Chief Financial Officer of the Company since April 2, 2001.
Mr. Kearns is responsible for all financial, treasury, administration, legal and
human resources functions within the Company. Mr. Kearns has over 20 years of
professional experience with publicly traded North American companies.
Previously, Mr. Kearns was Chief Financial Officer of O&Y Properties
Corporation. Mr. Kearns has been a certified management accountant since 1985.
  MILOS
DJOKOVIC was appointed as the Company’s Chief Operating Officer and Chief
Technical Officer in October, 2004.  Mr. Djokovic was the founder in 1992
of Cygnus Corporation, an Ontario based developer of customer relationship
management software, which he sold in 1998 to TeleTech Holdings Inc., and
continued to serve as its chief technical officer until March 2003.  Mr.
Djokovic also served as CEO of TeleTech’s Enhansiv division from
2000-2002.   From August 2003 until August 2004, Mr. Djokovic was
employed with Accenture, a management consulting firm, in which was he was
responsible for that firm’s customer relationship technology
strategy.
  
 GLEN
MORGAN was appointed Senior Vice President Global Sales and Marketing in May
2004. Mr. Morgan served as Executive Vice President and
Managing Director for Plano, Texas-based Mobility Ventures Group, a wireless
telecommunications company focused on acquisition and management strategies for
operators, enterprises and vendors. Prior to Mobility Ventures Group, Mr. Morgan
served as Senior Vice President, Sales for i3Mobile (NASD: IIIM), a leading
provider of wireless information services to the industry.
 
 
 58
   (a) Compensation
of Directors
  On
September 26, 2001, the Board approved director compensation, effective
January 1, 2002, of $10,000 per annum, payable in bi-annual instalments on
the 1 st day of
January and July of each year. In light of increased responsibilities required
to be undertaken by directors of public companies, the Board has instructed the
Compensation Committee to make recommendations for increases in director
compensation by the 2005 Annual General Meeting.
  The
Corporation reimburses all travel and other expenses of directors while
conducting business on behalf of the Corporation.
  Executive
officers of the Corporation, who also act as directors of the Corporation, do
not receive any additional compensation for services rendered in such capacity,
other than as paid by the Corporation to such executive officers in their
capacity as executive officers. (See “Compensation of Executive
Officers”.)
  During
the fiscal period ended December 31, 2004, stock options to purchase
400,000 Common Shares were granted to directors of the Corporation, not
including options granted to Michael E. Lobsinger in his capacity as Executive
Officer of the Corporation. See “Compensation of Executive Officers” for details
on stock options granted to Mr. Lobsinger.
  (b) Compensation
of Executive Officers
  1. Summary
Compensation
  The
following table sets forth all annual and long-term compensation for services in
all capacities to the Corporation for the period ended December 31, 2004, in
respect of individual(s) who were acting in a capacity of chief executive
officer, chief financial officer, and the three other most highly compensated
executive officers who earned in excess of CDN $150,000 in total salary and
bonus during the fiscal year ended December 31, 2004 (the “ **Named
Executive Officers** ”).
   59
  *Summary
compensation table*
  **Annual
      Compensation****(6)**
    
    **Long-Term
      Compensation****Awards**
    
    **Payouts****Name
      and principal position**
    
    **Year**
    
    **Salary**
      **($US)**
    
    **Bonus**
      **($US)**
    
    **Other
      annual compensation**
      **($US)**
    
    **Securities
      under options/**
      **SARs
      granted**
      **(#)**
    
    **Restricted
      shares or restricted stock units (“RSUs”)**
      **(#)**
    
    **LTIP
      payouts**
      **($US)**
    
    **All
      other compensation**
      **($US)**Michael E.
      Lobsinger(1)
      Chairman
    
    
    2004
      2003
      2002
    
    
    159,478
      354,821
      322,230
    
    
    180,427
      23,145
      38,212
    
    
    Note(5)
      Note(5)
      Note(5)
    
    
    450,000
      250,000
      nil
    
    
    250,000
      128,571
      nil
    
    
    nil
      nil
      nil
    
    
    nil
      nil
      nilMichael
      D. Donnell(2)
      Chief
      Executive Officer
    
    
    2004
      2003
    
    
    296,875
      99,808
    
    
    100,000
      nil
    
    
    Note(5)
      Note(5)
    
    
    nil
      740,000
    
    
    nil
      nil
    
    
    nil
      nil
    
    
    nil
      nilGary
      Mendel(3)
      Vice
      President, Sales and Marketing
    
    
    2004
      2003
      2002
    
    
    103,125
      165,000
      165,000
    
    
    54,587
      38,844
      25,000
    
    
    Note(5)
      Note(5)
      Note(5)
    
    
    10,000
      37,500
      10,000
    
    
    nil
      nil
      nil
    
    
    nil
      nil
      nil
    
    
    nil
      nil
      nilDale
      Kearns(4)
      Chief
      Financial Officer
    
    
    2004
      2003
      2002
    
    
    87,388
      81,190
      107,440
    
    
    57,644
      19,215
      nil
    
    
    46,067(8)
      26,136(8)
      nil
    
    
    100,000
      100,000
      nil
    
    
    nil
      3,906
      nil
    
    
    nil
      nil
      nil
    
    
    nil
      nil
      nilGlen
      Morgan(7)
      Senior
      Vice President, Global Sales and Marketing
    
    
    2004
    
    
    105,692
    
    
    nil
    
    
    nil
    
    
    100,000
    
    
    nil
    
    
    nil
    
    
    nil
  **Note** **s:**
  (1)On
January 1, 2000 Mr. Lobsinger was appointed Chairman and Chief
Executive Officer of the Corporation. On November 19, 2003, Mr Lobsinger
resigned as Chief Executive Officer. In 2003, Mr. Lobsinger agreed to defer
CDN$220,407 of his 2003 salary, included as part of his annual compensation,
payable to him under his employment agreement on December 31, 2006, unless
the directors determined to pay it earlier. In 2003, Mr. Lobsinger was awarded a
cash bonus of $25,000 for which payment was voluntarily deferred .. In 2004, Mr.
Lobsinger was paid all amounts that had previously been deferred.
 (2)Michael
Donnell was appointed President and Chief Operating Officer on July 23, 2003 and
Chief Executive Officer on November 19, 2003.
 (3)Gary
Mendel was appointed Vice President, Sales and Marketing on May 22, 2001
and resigned from his employment with the Corporation on August 13,
2004.
 (4)Dale
Kearns was appointed Chief Financial Officer of the Corporation on April 2,
2001. Mr. Kearns was awarded a bonus of $19,215 in respect of 2003 for which
payment was voluntarily deferred until 2004.
 (5)Other
annual compensation is less than CDN$50,000 and less than 10% of the salary and
bonus of the respective Named Executive Officer.
 (6)For
2004 compensation, all Canadian dollar denominated compensation was converted to
US dollars at 0.7685, being the average conversion rate for 2004.
 (7)Glen
Morgan was appointed Senior Vice President, Global Sales and Marketing on May
31, 2004.
 (8)Mr.
Kearns provided services during 2003 and 2004 to certain subsidiaries of the
Corporation for which he was compensated directly by those
subsidiaries.
 
 ***Stock
Options***
  The
following table sets forth information in respect of all stock options granted
to the Named Executive Officers of the Corporation during the fiscal year ended
December 31, 2004.
 
 60
   **Name**
    
    **Securities
      under Options/SARs granted**
      **(#)**
    
    **Percent
      of total Options/SARs granted to employees in financial
      year****(1)**
    
    **Exercise
      or base price**
      **($/Security)**
    
    **Market
      value of Securities underlying Options/SARs/ RSUs on the date of
      grant**
      **($/Security)**
    
    **Expiration
      date**Michael
      E. Lobsinger(2)
    
    
    700,000
    
    
    33.2
    %
    
    Note(2
    )
    
    Note(2
    )
    
    Note(2
    )Gary
      Mendel(3)
    
    
    10,000
    
    
    0.5
    %
    
    Note(3
    )
    
    Note(3
    )
    
    Note(3
    )Michael
      D. Donnell(4)
    
    
    nil
    
    
    nil
    
    
    Note(4
    )
    
    Note(4
    )
    
    Note(4
    )Dale
      Kearns(5)
    
    
    100,000
    
    
    4.7
    %
    
    Note(5
    )
    
    Note(5
    )
    
    Note(5
    )Glen
      Morgan(6)
    
    
    100,000
    
    
    4.7
    %
    
    Note(6
    )
    
    Note(6
    )
    
    Note(6
    )
  Notes:
 (1)During
the year, stock options and RSU’s exercisable into a total of
2,105,500 Common Shares were granted to directors, officers, and employees
of the Company.
 (2)During
the year, the Corporation issued the following stock options and RSU’s to Mr.
Lobsinger: options to acquire 400,000 Common Shares at CDN$3.60 and 250,000
RSU’s to acquire Common Shares, both expiring March 25, 2009 (which were issued
pursuant to an amendment to Mr. Lobsinger’s employment entered into in respect
of his resignation as chief executive officer and under which Mr. Lobsinger
waived future contractual entitlements to stock option grants) and options to
acquire 50,000 Common Shares at CDN$2.60 expiring September 16, 2009. The market
value of the Common Shares at the date of the grant was the same as the exercise
price for the options granted to Mr. Lobsinger in 2004.
 (3)During
the year, the Corporation issued the following stock options to Mr. Mendel:
options to acquire 10,000 Common Shares at CDN $3.60 expiring March 25, 2007.
The market value of the Common Shares at the date of the grant was the same as
the exercise price for all the options granted to Mr. Mendel in
2004..
 (4)During
the year, the Corporation issued no stock options to Mr. Donnell.
 (5)During
the year, the Corporation issued the following stock options to Mr. Kearns:
options to acquire 100,000 Common Shares at CDN$3.60 expiring March 25, 2009.
The market value of the Common Shares at the date of the grant was the same as
the exercise price for all the options granted to Mr. Kearns in
2004.
 (6)During
the year, the Corporation issued the following stock options to Mr. Morgan:
options to acquire 100,000 Common Shares at CDN$3.10 expiring March 25, 2009.
The market value of the Common Shares at the date of grant was the same as the
exercise price for all the options granted to Mr. Morgan in 2004.
 
 The
following table sets forth information in respect of all stock options and RSU’s
which were either exercised or not exercised by the Named Executive Officers
during the Corporation’s fiscal year ended December 31, 2004.
  **Aggregated
Option/SAR and RSU exercises during the most recently completed financial year
and financial year-end option/SAR values**
 
 **Name**
    
    **Securitiesacquired
      onexercise**
      **(#)**
    
    **Aggregate
      valuerealized****(1)**
      **($US)**
    
    **UnexercisedOptions/SARS/RSUs
      asat December 31, 2004exercisable/**
      **unexercisable**
    
    **Value
      of unexercisedin-the-MoneyOptions/SARs/RSUs
      atDecember 31, 2004****(2)****exercisable/**
      **Unexercisable
      ($US)**Michael E.
      Lobsinger
    
    
    650,000
    
    
    709,235
    
    
    Exercisable1,378,571
      Unexercisablenil
    
    
    Exercisable5,840,501
      UnexercisablenilGary
      Mendel
    
    
    37,500
    
    
    51,077
    
    
    Exercisablenil
      Unexercisablenil
    
    
    Exercisablenil
      UnexercisablenilMichael
      D. Donnell
    
    
    nil
    
    
    nil
    
    
    Exercisable453,332
      Unexercisable286,668
    
    
    Exercisable1,657,902
      Unexercisable1,237,772Dale
      Kearns
    
    
    110,000
    
    
    467,362
    
    
    Exercisable133,333
      Unexercisable66,667
    
    
    Exercisable78,423
      Unexercisable282,309Glen
      Morgan
    
    
    33,333
    
    
    150,654
    
    
    Exercisablenil
      Unexercisable66,667
    
    
    Exercisablenil
      Unexercisable286,403
  **Note** **s:**
  (1)The
aggregate of the difference between the market value of the underlying
securities at the time of exercise and the exercise price.
 (2)“In-the-money”
options refer to those options in respect of which the market value of the
underlying security as at the financial year-end, exceeds the exercise or base
price of the option, being the aggregate of the difference between the market
value of the securities as at December 31, 2004 and the exercise
price.
   61
 ******
 ***Long-term
Incentive Plans***
  The
Corporation currently has no long-term incentive plans, other than stock options
granted from time to time by the Board under the provisions of the Corporation’s
Incentive Stock Option Plans described herein.
  ***Stock
Appreciation Rights and Restricted Shares***
  No stock
appreciation rights were granted by the Company to the Named Executive Officers
of the Company during the last fiscal year ended December 31, 2004 or since
incorporation. In 2004, 250,000 RSU’s were granted and issued, in respect of
compensation, without performance criteria attached and at no cost to the
grantee. ****
  ***Stock
Option and SAR Repricing***
  No
repricing took place during the fiscal year ended December 31, 2004 with
respect to stock options held by the Named Executive Officers.
  ***Pension
and Retirement Plans and Payments made upon Termination of
Employment***
  The
Corporation does not have any pension or retirement plan which is applicable to
the Named Executive Officers other than as described below. The Corporation has
not provided compensation, monetary or otherwise, during the preceding fiscal
year, to any person who now acts or has previously acted as a Named Executive
Officer of the Corporation, in connection with or related to the retirement,
termination or resignation of such person other than as described in the
succeeding paragraph and the Corporation has provided no compensation to such
persons as a result of a change of control of the Corporation, its subsidiaries
or affiliates. The Corporation is not party to any compensation plan or
arrangement with any person who now acts as a Named Executive Officer resulting
from the resignation, retirement or the termination of employment of such person
other than as described herein.
  ***Employment
Contracts***
  The
Corporation entered into an employment agreement with Michael E. Lobsinger dated
December 31, 1999 for a term that commenced on January 1, 2000 and
ended on December 31, 2002. The agreement provided for an automatic renewal
for a further three years on the same terms and conditions except for
remuneration which was to be renegotiated. Mr. Lobsinger was appointed
Chairman of the Board of the Corporation and Chief Executive Officer. The terms
of the agreement provided that Mr. Lobsinger be paid an amount equal to
US$300,000 per annum plus transportation and travel allowances. Effective
May 1, 2003, Mr. Lobsinger agreed to defer two-thirds of his
remuneration until a later date, and the Corporation ceased paying
Mr. Lobsinger the full amount of his salary. Effective November 20, 2003
Mr. Lobsinger and the Corporation agreed that the positions of Chairman of
the Board and Chief Executive Officer would be separated, such that
Mr. Lobsinger would no longer be Chief Executive Officer of the Corporation
but would remain as Chairman of the Board. The Corporation and
Mr. Lobsinger entered into an Amending Agreement in March, 2004 that
amended the terms of his employment agreement effective November 20, 2003
(the “Amending Agreement”). (Mr. Donnell became Chief Executive Officer of the
Corporation on that date). Mr. Lobsinger agreed to amend the terms of his
employment to reduce his salary to an annual compensation of CDN$225,000 per
year effective November 20, 2003. In addition, as of November 20, 2003,
Mr. Lobsinger had deferred CDN$240,340 in salary payable to him under his
employment agreement, which he agreed to further defer until December 31,
2006, unless the directors determined to pay it earlier. This amount was paid to
Mr. Lobsinger on September 17, 2004. Mr. Lobsinger agreed to forego
any additional options that he would have been entitled to under his 1999
employment agreement, and instead the Corporation agreed to issue to him 400,000
options and 250,000 RSU’s. Under the Amending Agreement, following a change of
control Mr. Lobsinger has the right, exercisable within 60 days of a change
of control, to consider his employment to have been terminated. In the event the
Corporation terminates Mr. Lobsinger’s employment (or Mr. Lobsinger
elects to treat his employment as terminated on a change of control) the
Corporation is required to pay him an amount equal to three times his current
annual salary and at Mr. Lobsinger’s discretion, an amount equal to the
difference between the fair market value of all options, whether vested or not,
and the exercise price. In addition, any salary amounts deferred by
Mr. Lobsinger as of the date of his termination becomes payable upon such
termination.
   62
  The
Corporation entered into an employment agreement with Gary Mendel effective
May 22, 2001. Mr. Mendel was appointed Vice President, Sales and
Marketing of the Corporation. The terms of the agreement provided that
Mr. Mendel be paid US$165,000 per annum and provide for a bonus of up to
50% of annual salary based upon the performance of mutually agreed milestones,
payable in cash or stock options as follows: 50% to be paid in cash or options
at the discretion of the employee and 50% at the discretion of the reporting
manager. The bonus will be payable bi-annually. Options will be valued based on
current pricing models. The Corporation agreed, subject to regulatory approvals,
to grant Mr. Mendel stock options to purchase 60,000 Common Shares in the
capital of the Corporation.
The Corporation may terminate Mr. Mendel’s employment upon 90 days’ written
notice, or payment of three
months base salary. In the event of a change of control of the Corporation,
Mr. Mendel may, at his discretion, terminate the agreement. In addition,
his options will all become immediately exercisable and he will have 90 days to
exercise those options. Mr. Mendel was required to execute a
Confidentiality and Non-Competition agreement. Mr. Mendel resigned his position
with the Corporation on July 13, 2004.
  The
Corporation entered into an employment agreement with Michael D. Donnell on July
23, 2003 pursuant to which Mr. Donnell was appointed President and Chief
Operating Officer of the Corporation. The terms of the agreement provided for
Mr. Donnell to be paid a base salary of US$225,000 per annum. The
Corporation may terminate Mr. Donnell’s employment upon payment of three
month’s salary. The Corporation agreed, subject to regulatory approvals, to
grant Mr. Donnell stock options to purchase 250,000 Common Shares in the
capital of the Corporation. On November 23, 2003 Mr. Donnell was
appointed Chief Executive Officer at which time he was awarded 490,000 options
to purchase Common Shares of the Corporation and his base salary increased to
US$300,000 per annum. Pursuant to Mr. Donnell’s employment contract, in the
event of a change of control of the Corporation, all of his options would vest
immediately. Mr. Donnell was required to execute a Confidentiality and
Non-Competition agreement.
   63
  The
Corporation entered into an employment agreement with Dale Kearns on April 2,
2001 pursuant to which Mr. Kearns was appointed Chief Financial Officer of the
Corporation. The terms of the agreement provided for Mr. Kearns to be paid a
base salary of CDN$180,000 per annum. Pursuant to a 2004 amendment to the
employment agreement, the Corporation may terminate Mr. Kearns’ employment upon
payment of twelve months’ base salary plus an allowance to replace group
insurance benefits post-termination of employment. The Corporation agreed,
subject to regulatory approvals, to grant Mr. Kearns’ stock options to purchase
60,000 Common Shares in the capital of the Corporation. Pursuant to Mr. Kearns’
employment contract, in the event of a change of control of the Corporation, all
of his options would vest immediately. Mr. Kearns was required to execute a
Confidentiality and Non-Competition agreement.
  The
Corporation entered into an employment agreement with Milos Djokovic on
October 25, 2004 pursuant to which Mr. Djokovic was appointed Chief
Technology Officer and Chief Operating Officer of the Corporation. The terms of
the agreement provide for Mr. Djokovic to be paid a base salary of US$230,000
per annum. The Corporation may terminate Mr. Djokovic’s employment upon payment
of up to six months’ base salary. The Corporation agreed, subject to regulatory
approvals, to grant Mr. Djokovic stock options to purchase 230,000 Common Shares
in the capital of the Corporation. Pursuant to Mr. Djokovic’s employment
contract, in the event of a change of control of the Corporation, all of his
options would vest immediately. Mr. Djokovic was required to execute a
Confidentiality and Non-Competition agreement.
  The
Corporation entered into an employment agreement with Glen Morgan on May 31,
2004 pursuant to which Mr. Morgan was appointed Senior Vice President, Global
Sales and Marketing. The terms of the agreement provide for Mr. Morgan to be
paid a base salary of US$180,000 per annum. The Corporation may terminate Mr.
Morgan’s employment upon payment of three months’ base salary if terminated
during the first 18 months of employment and six months’ base salary thereafter.
The Corporation agreed, subject to regulatory approvals, to grant Mr. Morgan
stock options to purchase 100,000 Common Shares in the capital of the
Corporation. Pursuant to Mr. Morgan’s’ employment contract, in the event of a
change of control of the Corporation, all of his options would vest immediately.
Mr. Morgan was required to execute a Confidentiality and Non-Competition
agreement.
  (c) Plans
and Share Options
  The
Company currently has in effect, 1993, 1995, 1996, 1998 and 1999 Incentive Share
Option Plans for its directors, officers, employees and consultants pursuant to
which 11,615,000 common shares were reserved for issuance and an additional
1,300,000 common shares which were reserved for issuance pursuant to
shareholder approval obtained at the June 5, 2002 shareholder
meeting.
  The
following summarizes aggregate stock option plan activity during the fiscal
years ending December 31, 2002, 2003 and 2004:
 
 
 64
   **2004**
    
    **2003**
    
    **2002**Options
      outstanding, beginning of year
    
    
    5,474,904
    
    
    5,135,700
    
    
    5,874,852Granted
    
    
    2,105,500
    
    
    2,342,532
    
    
    306,666Cancelled
    
    
    (1,524,666
    )
    
    (1,667,701
    )
    
    (741,218
    )Exercised
    
    
    (1,143,766
    )
    
    (335,627
    )
    
    (304,600
    )Options
      outstanding, end of year
    
    
    **4,911,972**
    
    
    **5,474,904**
    
    
    **5,135,700**
 
  (d) Other
Compensation
  During
the Corporation’s fiscal year ended December 31, 2004, the Corporation
accrued and/or paid legal fees to a law firm of which one of the directors of
the Corporation was a partner amounting, in the aggregate, to
US$125,708.
  A
management fee was paid by the Corporation to a consulting firm owned by an
officer amounting to CDN$60,000 during the fiscal year ended December 31,
2004.
  A
management fee was paid by the Corporation to a consulting firm owned by a
director amounting to US$30,000 during the fiscal year ended December 31,
2004.
  The
Corporation has set forth herein all required disclosure of additional
compensation to the executive officers or directors (including personal benefits
and securities or properties paid or distributed which compensation was not
offered on the same terms to all full time employees) during the last completed
fiscal year.
  ***B.*** ***Board
Practices***
  (a) Board
of Directors
  The Board
currently consists of eight members. Each director elected will hold office
until the next annual meeting of shareholders or until his successor is duly
elected, unless his office is earlier vacated in accordance with the Bylaws of
the Company.
  Board
Committees
  Our board
of directors has three standing committees: an Audit Committee, a Compensation
Committee and a Corporate Governance and Nominating Committee.
  *Audit
Committee*
  The Audit
Committee consists of three members. Mr. Donald Hyde, who is a chartered
accountant in private practice, joined the Board in June, 2003 and was
immediately appointed Chairman of the Audit Committee. Mr. Hyde was specifically
recruited to the Corporation’s Board of Directors for his financial and
accounting skills. Other members of the Audit Committee are Thompson MacDonald
and Michael Mackenzie are financially literate and possess an understanding of
the accounting principles, internal controls and procedures used by the Company.
Messrs. MacDonald and Mackenzie are presently and have served as directors or
senior officers of companies who prepare financial statements similar to those
of the Company and have experience supervising one or more persons engaged in
the preparation of financial statements. All members of the Audit Committee are
outside and unrelated directors and independent from any interest in the
Corporation. The Committee met four times in 2003 and all members attended all
of the meetings.
   65
  The
Corporation adopted an Audit Committee Charter in June 2000 which was recently
amended to conform with applicable requirements. A copy of the Audit Committee
Charter is filed as an exhibit to this Report. The stated purpose of the Audit
Committee is to serve as an independent and objective party to monitor the
integrity of the Corporation’s financial reporting process and system of
internal controls, to review, appraise and monitor the independence and
performance of the Corporation’s independent auditors and to provide an avenue
for open communication among the independent auditors, management and the Board
of Directors. All members of the Audit Committee are financially literate and
possess an understanding of the accounting principles, internal controls and
procedures used by the Company. In addition, the Audit Committee reviews the
independence and performance of its auditors and approves the fees and other
significant compensation to be paid to the independent auditors. The Audit
Committee has direct access to the independent auditors at all times and has the
ability to retain, at the Corporation’s expense, special legal, accounting or
other consultants or experts it deems necessary in the performance of its
duties.
  *Compensation
Committee*
  During
2004, the Compensation Committee consisted of Michael Mackenzie, as Chairman,
Rod Love and Donald Hyde. Mr. Love resigned in November 2004. Donald Moore was
selected to serve on the Compensation Committee in March 2005. All three members
are considered unrelated and independent directors. Under its charter, the
Compensation Committee is responsible for reviewing management prepared policies
and recommending to the Board of Directors the compensation policies and
guidelines for senior officers and management personnel, corporate benefits,
incentive plans, evaluation of the performance and compensation of the Chief
Executive Officer and other senior management, compensation level for members of
the Board of Directors and committee members, a succession plan for the Chief
Executive Officer and key employees of the Corporation and any material changes
in human resources policy, procedure, remuneration and benefits.
  The
Compensation Committee advises the board on the administration of the Company’s
Stock Option Plans, and reviews and approves the recommendations of senior
management relating to the annual salaries, bonuses and stock option grants of
the executive officers of the Company. The Compensation Committee consists of
outside directors who report to the Board, which in turn gives final approval to
compensation matters.
  Under the
direction of the Compensation Committee, the Company is committed to the
fundamental principles of pay for performance, improved shareholder returns and
external competitiveness in the design, development and administration of its
compensation programs. The Compensation Committee recognizes the need to attract
and retain a stable and focused leadership with the capability to manage the
operations, finances and assets of the Company. As appropriate, the Compensation
Committee recognizes and rewards exceptional individual contributions with
highly competitive compensation. The major elements of the Company’s executive
compensation program are salary, annual cash incentives and long-term
incentives, through the granting of stock options and Restricted Stock Units
(“RSU’s”).
  In
connection with determining base salaries, the Company maintains an
administrative framework of job levels into which positions are assigned based
on internal comparability and external market data. Because of the Company’s
lean organizational structure and growth in the international arena, the
Compensation Committee’s goal is to provide base salaries, for its top
performing employees, that are competitive with the Company’s peers and which
also recognizes the differentials from such peers. The Committee references
outside data consisting of management compensation surveys and reports compiled
by such organizations as Korn-Ferry International Consultants, The Wynford Group
Management Consulting, Haygroup Ltd., Watson Wyatt, Western Compensation and
Benefits Consultants and KPMG LLP and compare the base salaries of the Company’s
executive officers with compensation data for comparable organizations available
from such surveys and reports.
   66
  Annual
cash incentive awards are given pursuant to an Incentive Compensation Plan,
approved by the Board. Participation is determined according to job level and is
intended to reward those individuals who have had, and will have a significant
impact on business results. The total amount of cash available for annual
incentive awards is determined by the Compensation Committee by evaluating a
combination of financial and non-financial criteria, including net
income/operating profit, cash flow, net asset value growth and achievement of
specific strategic goals. Individual target award levels increase in relation to
job responsibilities so that the ratio of at-risk versus fixed compensation is
greater for higher levels of management. Individual awards are intended to
reflect a combination of personal, business unit and total company performance.
In 2004, the Board approved up to a combined total of $250,000 in cash bonuses
to be paid to three executives in respect of 2004. In determining bonuses, the
Committee considers profitability, as well as development growth, sales and
customer growth, implementation of Zi product to its customers and individual
effort in overall corporate development.
  The Board
believes that employees should have a stake in the future of the Corporation and
that their interests should be aligned with the interest of the Corporation’s
stockholders. To this end, the Committee selects those executives and key
employees whose decisions and actions can most directly impact business results
to participate in the Stock Option Plans. Under the Stock Option Plans, officers
and key employees who are selected to participate are eligible to receive stock
options that may be granted subject to a vesting period determined by the
Corporation and approved by the Board to create a long-term incentive to
increase shareholder value. Awards of stock options and RSU’s are supplementary
to the cash incentive plan and are intended to increase the pay-at-risk
component for officers and key employees. No RSU’s have been issued as at the
February 28, 2005 in respect of 2004 incentive compensation.
  We have
employment agreements or remuneration arrangements with all of our executive
officers. Each agreement or arrangement provides for salary, benefits, bonuses
and incentive stock option grants for the executive officer, and for
compensation if his or her employment is terminated. For employment agreements
of Named Executive Officers, see *Item 6 -
Compensation of Executive Officers* . Except
as described herein, there are no agreements or other remuneration arrangements
with any of our directors.
  *Corporate
Governance and Nominating Committee*
  During
2004, this Committee had three members;. Derrick Armstrong, who was the Chairman
of the Committee, Thompson MacDonald and Howard Balloch. In 2005, Richard Tingle
joined the Corporate Governance Committee and Derrick Armstrong resigned. Howard
Balloch assumed the Chairmanship of the Committee. The Corporation had adopted a
charter for this committee which has been posted on its website. Pursuant to its
charter, the Corporate Governance and Nominating Committee takes responsibility
for preparing the disclosure in the Information Circular concerning corporate
governance, and for developing and monitoring the Corporation’s general approach
to corporate governance issues as they arise. It also assumes responsibility for
assessing current members and nominating new members to the Board of Directors
and ensuring that all board members are informed of and are aware of their
duties and responsibilities as a director of the Corporation. The Corporate
Governance and Nominating Committee takes responsibility for the adoption of
adequate policies and procedures to allow the Corporation to meet its continuous
disclosure requirements, manage the principal risks of the Corporation, review
the strategic plan on a timely basis, develop and monitor corporate policies
relating to trading in securities, ensuring the Board annually reviews
organizational structure and succession planning, reviews areas of potential
personal liability of directors and ensures reasonable protective measures are
in place and causes the Board to annually review its definition of an unrelated
director. The Committee met formally one time in 2004 and, in view of its size,
communicated informally from time to time.
   67
  The
Company’s approach to corporate governance with reference to the TSE Guidelines
is set out in the Company’s Management Information Circular. See
Exhibit 10.1.
  ***C.*** ***Employees***
  As of
March 23, 2005, we had 119 regular, full-time employees:
  **ZI
      TECHNOLOGY****Asia**
    **North
      America**
    **Europe**
    **Total**Sales &
      Marketing
    5
    4
    3
    12Technical
    4
    24
    9
    37Admin/Corp
    6
    14
    3
    23**ZI
      TECHNOLOGY TOTAL**
    **15**
    **42**
    **15**
    **72**
 
 **OZTIME****Asia**
    **North
      America**
    **Europe**
    **Total**Sales &
      Marketing
    9
    1
    -
    10Technical
    32
    -
    -
    32Admin/Corp
    5
    -
    -
    5**OZTIME
      TOTAL**
    **46**
    **1**
    **-**
    **47**
 
 We
believe that our future success will depend on our continued ability to attract
and retain highly skilled and qualified employees. None of our employees are
represented by a collective bargaining agreement. At December 31, 2003 we
had 104 regular, full time employees; at December 31, 2002, we had
103 regular, full-time employees; and at December 31, 2001, we had
168 regular, full-time employees. We believe we enjoy good relationships
with our employees.
   68
  ***D.*** ***Share
Ownership***
  (a) Share
and Option Holdings
   The
following table sets forth the direct and indirect actual common share ownership
and option holdings of our directors and previously Named Executive Officers at
March 23, 2005.
  **Name**
    
    **Number
      of Shares Beneficially Owned***
    
    **Percentage
      of**
      **Class****Michael E.
      Lobsinger
    
    
    5,819,613(1
    )
    
    12.2
    %Derrick R.
      Armstrong
    
    
    274,900(2
    )
    
    0.6
    %Howard R.
      Balloch
    
    
    325,350(3
    )
    
    0.7
    %H.
      Donald Hyde
    
    
    100,000(4
    )
    
    0.2
    %Thompson
      MacDonald
    
    
    80,000(5
    )
    
    0.2
    %Angus
      Michael Roderick Mackenzie
    
    
    525,000(6
    )
    
    1.1
    %Donald
      P. Moore
    
    
    50,200(7
    )
    
    0.1
    %Richard
      Tingle
    
    
    50,000(8
    )
    
    0.1
    %Mike
      D. Donnell
    
    
    513,333(9
    )
    
    1.1
    %Dale
      Kearns
    
    
    166,672(10
    )
    
    0.4
    %Milos
      Djokovic
    
    
    76,667(11
    )
    
    0.2
    %
   **Notes:**
 
 *
    Includes options and restricted stock units exercisable
      within 60 days of March 23, 2005. Except as noted to the contrary, in
      notes 1 to 11 below all grant prices are expressed in Canadian
      dollars.
 
 **
    Based
      upon the number of outstanding Common Shares, as of March 23,
      2005.
  (1)Based
upon the number of outstanding In the case of Mr. Lobsinger, this comprises
1,143,700 common shares held directly or beneficially by
Mr. Lobsinger, 3,297,342 common shares held by Quarry Bay Investments
Inc., a private Alberta corporation wholly-owned by Mr. Lobsinger, and
1,378,571 share options and RSU’s. The share options and RSU’s include:
200,000 options granted December 28, 2000 at a grant price of $10.05
and expire December 28, 2005; 50,000 options granted January 1,
2001 at a grant price of $9.20 and expire January 1, 2006;
50,000 options granted December 3, 2001 at a grant price of $7.96 and
expire December 3, 2006; 50,000 options granted January 1, 2003
at a grant price of $4.40 and expire January 1, 2006; 100,000 options
granted April 17, 2003 at a grant price of $2.56 and expire on
April 17, 2008; and 28,571 RSU’s at a grant price of nil and expire on
April 17, 2008; 100,000 options granted on June 11, 2003 at a grant price
of $3.43 and expire on June 11, 2008; 100,000 RSU’s on June 11, 2003 at a grant
price of nil and expire on June 11, 2008; 400,000 options granted March 25, 2004
at a grant price of $3.60 and expire March 25, 2009; 250,000 RSU’s at a grant
price of nil and expire on March 25, 2009, 50,000 options at a grant price of
$2.60 and expire on September 16, 2009.
  (2) In
the case of Mr. Armstrong, this comprises 194,900 common shares held
directly or beneficially by Mr. Armstrong and 80,000 share options.
This does not include 10,000 common shares held pursuant to a spousal RRSP.
The share options include: 30,000 options granted June 11, 2003 at a grant price
of $3.43 and expire on June 11, 2008, 50,000 options at a grant price of $2.60
and expire on September 16, 2009.
  (3) In
the case of Mr. Balloch, this comprises 350 common shares held
directly or beneficially by Mr. Balloch and 225,000 share options
granted August 4, 2001 at a grant price of $11.66 and expire July 31,
2006; 50,000 options granted June 11, 2003 at a grant price of $3.43 and expire
on June 11, 2008, 50,000 options at a grant price of $2.60 and expire on
September 16, 2009.
   69
  (4) In
the case of Mr. Hyde, this comprises 100,000 share options: 50,000 options
granted June 11, 2003 at a grant price of $3.43 and expire on June 11, 2008,
50,000 options at a grant price of $2.60 and expire on September 16,
2009.
  (5) In
the case of Mr. MacDonald, this comprises 80,000 share options which
include: 30,000 options granted June 11, 2003 at a grant price of $3.43 and
expire on June 11, 2008, 50,000 options at a grant price of $2.60 and expire on
September 16, 2009.
  (6) In
the case of Mr. Mackenzie, this comprises 200,000 common shares held
directly or beneficially by Mr. Mackenzie and 325,000 share options.
The share options include: 100,000 options granted July 26, 2000 at a
grant price of $13.50 and expire July 26, 2005; 125,000 options
granted June 8, 2001 at a grant price of $12.23 and expire June 8,
2006; 50,000 options granted June 11, 2003 at a grant price of $3.43 and expire
on June 11, 2008, 50,000 options at a grant price of $2.60 and expire on
September 16, 2009.
  (7) In
the case of Mr. Moore, this comprises 50,000 share options: 50,000 options
at a grant price of $2.60 and expire on September 16, 2009.
  (8) In
the case of Mr. Tingle, this comprises 50,000 share options: 50,000 options
at a grant price of $7.79 and expire on January 10, 2010.
  (9) In
the case of Mr. Donnell, this comprises 513,333 share options: 250,000 share
options granted July 24, 2003 at a grant price of $4.94 and expire July 24,
2008; 263,333 options granted November 17, 2003 at a grant price of $3.50 and
expire November 17, 2008.
  (10) In
the case of Mr. Kearns, this comprises 6 common shares held directly or
beneficially by Mr. Kearns and 166,666 share options, 60,000 share options
granted April 1, 2001 at a grant price of $10.71 and expire April 1, 2006;
60,000 options granted December 6, 2001 at a grant price of $8.25 and expire
December 6, 2006, 46,666 options granted March 25, 2004 at a grant price of
$3.60 and expire March 25, 2009.
  (11) In
the case of Mr. Djokovic, this comprises 76,667 share options: 76,667 options
granted October 26, 2004 at a grant price of US$3.40 and expire October 26,
2009.
  (b)  Option
Plans
  ***Purpose
of Plans***
  The
purpose of the Plans is to advance the interests of the Corporation or any of
its subsidiaries or affiliates by encouraging the directors, officers, employees
and consultants to acquire shares in the Corporation, thereby increasing their
proprietary interest in the Corporation, encouraging them to remain associated
with the Corporation or any of its subsidiaries or affiliates and furnishing
them with additional incentive in their efforts on behalf of the Corporation or
any of its subsidiaries or affiliates.
  ***Eligibility***
  The Plans
provide for the issuance of options (“Options”) and RSUs exercisable to acquire
Common Shares of the Corporation to directors, officers, employees and
consultants, including a personal holding Corporation controlled by one of the
aforementioned participants, a participant’s spouse, children and/or
grandchildren and a consulting corporation engaged to provide ongoing consulting
services for the Corporation or any of its subsidiaries or affiliates. Options
and/or RSUs may be granted, either alone or in addition to, in tandem with or in
substitution for any other Options or RSUs previously granted. The specific
terms of each Option are provided in a separate Option Agreement (“Option
Agreement”), and the specific terms of each RSU are provided in a separate
Restricted Stock Unit Agreement (“RSU Agreement”).
   70
  RSUs are
notional credits maintained on the books of the Corporation; the value of each
RSU reflects the value of one Common Share and entitles the holder to receive
one Common Share from the treasury of the Corporation. Each RSU granted to
participants will be subject to individual terms specified by the Committee in
the RSU Agreement, including the time or times at which the RSU may be
exercised.
 
 The
number of Common Shares that may be issued under the Plans is subject to
appropriate adjustment in the event of certain corporate transactions or
events.
  ***Administration
of the Plans***
  The Plans
are administered by the Board, or if appointed, a special committee of directors
appointed by the Board (such a special committee or the Board, if no special
committee is appointed, is referred to in this prospectus as the “Committee”),
whose members have responsibility for designating participants under the Plans
and, subject to the terms of the Plans, for setting the terms of Options and
RSUs. Unless otherwise expressly provided in the Plans, all designations,
determinations, interpretations and other decisions under or with respect to the
Plans or any Option or RSU shall be within the sole discretion of the Committee,
may be made at any time and shall be final, conclusive and binding upon any
participant, any holder or beneficiary of any Option or RSU. In determining
which eligible persons shall receive an Option or RSU and the terms of any
Option or RSU, the Committee may take into account the nature of the services
rendered by the respective person, his or her present and potential
contributions to the success of the Corporation or such other factors as the
Committee, in its discretion, deems relevant. If the Board appoints a special
committee to serve as the Committee, the Board may from time to time increase
and thereafter decrease the size of such special committee and may fill any
vacancies however created.
  ***Amendment
of the Plans***
  Subject
to any required approval of any stock exchange on which the Corporation’s
securities are listed, the Board reserves the right to amend, suspend or
terminate the Plans at any time if and when it is advisable in the absolute
discretion of the Board or Committee; provided however, no such amendment or
revision shall alter the terms of any Options or RSUs theretofore granted under
the Plans.
  ***Necessary
Approvals***
  The
ability of the Options or RSUs to be exercised and the obligation of the
Corporation to issue and deliver shares in accordance with the Plans is subject
to any approvals that may be required from the shareholders of the Corporation,
or any regulatory authority or stock exchange having jurisdiction over the
securities of the Corporation.
  ***Adjustment
in Shares Subject to the Plan***
  Other
than dividends declared in the normal course, appropriate adjustments in the
number of Common Shares optioned, in the option price per share, as regards
Options granted or to be granted, and in the RSUs granted or to be granted, may
be made by the Committee in its discretion to give effect to adjustments in the
number of Common Shares of the Corporation resulting subsequent to the approval
of the Plans by the Committee from subdivisions, consolidations or
reclassification of the Common Shares of the Corporation, the payment of stock
dividends by the Corporation or other relevant changes in the capital of the
Corporation.
   71
  The
number of Common Shares that may be issued under the Plans is subject to
appropriate adjustment in the event of certain corporate transactions or
events.
  Options
provide the holder with the right to purchase Common Shares at a stated exercise
price before a specified date in the future. The exercise price for Options
shall not be less than the price permitted by any stock exchange on which the
Shares are then listed or other regulatory body having jurisdiction. The
exercise price of Options granted under the Plans must be equal to not less than
100% of the fair market value of the Common Shares on the date of grant, which
shall be determined based on the closing price for board lots of Common Shares
listed on The Toronto Stock Exchange on the last day of the trading immediately
preceding the date of the grant.
  A
comparative chart highlighting the significant terms of each of the Plans is as
follows:
  **1993**
      **Plan**
    
    **1995**
      **Plan**
    
    **1996**
      **Plan**
    
    **1998**
      **Plan**
    
    **1999**
      **Plan**
      **(as
      amended in 2000 and 2002)****Eligible
      participants**
    
    Directors,
      officers, employees, consultants and their associates.
    
    Directors,
      officers, employees, consultants and their associates.
    
    Directors,
      officers, employees, consultants and their associates.
    
    Directors,
      officers, employees, consultants and their associates.
    
    Directors,
      officers, employees, consultants and their associates.**Number
      of securities issued/issuable**
    
    Not
      to exceed the maximum number of shares permitted under the rules of any
      regulatory body having jurisdiction.
    
    Not
      to exceed 1,430,000 Common Shares.
    
    Not
      to exceed 2,600,000 Common Shares.
    
    Not
      to exceed 1,300,000 Common Shares.
    
    Not
      to exceed 4,960,000 Common Shares and 500,000 RSUs.**Maximum
      percentage available to insiders**
    
    Not
      to exceed the maximum number of shares permitted under the rules of any
      regulatory body having jurisdiction.
    
    Not
      to exceed 10% of the outstanding issue.
    
    Not
      to exceed 10% of the outstanding issue.
    
    Not
      to exceed 10% of the outstanding issue.
    
    Not
      to exceed 10% of the outstanding issue.**Maximum
      number of securities to any one entity**
    
    Not
      to exceed the maximum number of shares permitted under the rules of any
      regulatory body having jurisdiction.
    
    Not
      to exceed 5% of the outstanding issue.
    
    Not
      to exceed 5% of the outstanding issue.
    
    Not
      to exceed 5% of the outstanding issue.
    
    Not
      to exceed 5% of the outstanding issue.**Method
      for determining the exercise price**
    
    Determined
      by the Board or Committee, but shall not be less than the price permitted
      by any regulatory body.
    
    Determined
      by the Board or Committee, but shall not be less than the price permitted
      by any regulatory body.
    
    Determined
      by the Board or Committee, but shall not be less than the price permitted
      by any regulatory body.
    
    Determined
      by the Board or Committee, but shall not be less than the price permitted
      by any regulatory body.
    
    Determined
      by the Board or Committee, but shall not be less than the price permitted
      by any regulatory body.**Method
      for determining the purchase price**
    
    Determined
      by the Board or Committee at the time any option is granted but shall not
      be lower than the Market Price.
    
    Determined
      by the Board or Committee at the time any option is granted but shall not
      be lower than the Market Price.
    
    Determined
      by the Board or Committee at the time any option is granted but shall not
      be lower than the Market Price.
    
    Determined
      by the Board or Committee at the time any option is granted but shall not
      be lower than the Market Price.
    
    Determined
      by the Board or Committee at the time any option is granted but shall not
      be lower than the Market Price.**Vesting
      of stock options**
    
    Determined
      by the Board or Committee.
    
    Determined
      by the Board or Committee.
    
    Determined
      by the Board or Committee.
    
    Determined
      by the Board or Committee.
    
    Determined
      by the Board or Committee.**Term
      of stock options**
    
    Fixed
      by the Board or Committee.
    
    Fixed
      by the Board or Committee, subject to a 10 year maximum.
    
    Fixed
      by the Board or Committee, subject to a 10 year maximum.
    
    Fixed
      by the Board or Committee, subject to a 10 year maximum.
    
    Fixed
      by the Board or Committee, subject to a 10 year maximum.**Causes
      of cessation of entitlement**
    
    Resignation
      of Participant status or death.
    
    Resignation
      of Participant status or death.
    
    Resignation
      of Participant status or death.
    
    Resignation
      of Participant status or death.
    
    Resignation
      of Participant status or death.**Assignability**
    
    Not
      transferable or assignable.
    
    Not
      transferable or assignable.
    
    Not
      transferable or assignable.
    
    Not
      transferable or assignable.
    
    Not
      transferable or assignable.**Procedure
      for amending**
    
    Subject
      to regulatory approval, the Committee or Board may suspend, terminate,
      amend or revise the Plan.
    
    Subject
      to regulatory approval, the Committee or Board may suspend, terminate,
      amend or revise the Plan.
    
    Subject
      to regulatory approval, the Committee or Board may suspend, terminate,
      amend or revise the Plan.
    
    Subject
      to regulatory approval, the Committee or Board may suspend, terminate,
      amend or revise the Plan.
    
    Subject
      to regulatory approval, the Committee or Board may suspend, terminate,
      amend or revise the Plan.
   72
  **Item 7
-** **Major
Shareholders and Related Party Transactions**
  ***A.*** ***Major
Shareholders***
  To the
knowledge of the Company, the following table sets forth the names of each of
the persons or entities who beneficially hold, directly or indirectly, or
exercise control or direction over more than five percent (5%) of the
voting rights attached to the issued and outstanding shares of the Company
entitled to vote at the shareholder meetings of the Company as at March 23,
2005.
   73
   **Name
      and municipality**
    **Beneficial
      number**
      **of
      shares held**
    **Percentage
      of total**
      **voting
      rights**Marty
      Steinberg, Receiver
      Miami,
      Florida
    18,720,508
    40.5Michael
      E. Lobsinger(1)
      Calgary,
      Alberta
    4,441,042
    9.6
  **Note** **s:**
  (1)
    Marty
      Steinberg has represented to the Corporation that he is the court
      appointed Receiver of Lancer Management Group LLC, and related entities to
      Lancer Management Group LLC and responsible person for other related
      parties that are currently debtors in possession under a Chapter 11
      case pending before United States courts. Marty Steinberg is a lawyer with
      and represented by the law firm Hunton & Williams LLP of Miami,
      Florida. The information provided herein is based upon filings made on the
      SEDI insider trading reporting system in Canada and on a Schedule 13D (the
      “Schedule 13D”) filed on December 11, 2003 with the U.S. Securities and
      Exchange Commission by Marty Steinberg, Esq., as Receiver (the “Receiver”)
      of Lancer Management Group, LLC, Lancer Management Group II, LLC, Lancer
      Offshore, Inc., Lancer Partners, LP, LSPV, Inc., LSPV, LLC, Omnifund, Ltd,
      G.H. Associates, Inc., and Alpha Omega Group (the “Receivership
      Entities”). In the Schedule 13D the Receiver states that due to the poor
      condition of the records of the Receivership Entities he does not
      represent the truthfulness or accuracy of the Schedule 13D and the
      Corporation takes no responsibility for the information provided herein
      based on the Schedule 13D. The Schedule 13D was amended on January 28,
      2005.
 
 (1)
    Of
      which 1,143,700 common shares are held directly or beneficially by
      Mr. Lobsinger and 3,297,342 are held by Quarry Bay Investments Inc.,
      a private Alberta corporation wholly-owned by
      Mr. Lobsinger.
 
  The
Company’s major shareholders hold common shares, which shares do not carry
different voting rights than any other shares.
  Based on
a report from Olympia Trust Company, as at December 31, 2004, there were
196  registered
shareholders in the United States that held 25,817,683 common shares or 57.1
percent of the common shares outstanding.
  To the
extent known to the Company, the Company is not directly or indirectly owned or
controlled by any foreign government, or by any other natural or legal persons,
severally or jointly.
  ***B.*** ***Related
Party Transactions***
  Except as
set forth below and other than employment agreements with executive officers,
stock option grants described elsewhere in this report or as otherwise disclosed
in this report, the Company is not aware of any related party transactions
occurring or being made, or any loans made by the Company or any of its
subsidiaries to related parties, from January 1, 2004 to March 23, 2005,
other than the following:
  January
1, 2005 to March 23, 2005
  During
the Corporation’s period from January 1, 2005 to March 23, 2005, the Corporation
accrued and/or paid legal fees to a law firm of which one of the directors of
the Corporation was a partner amounting, in the aggregate, to
$27,432.
  A
management fee was paid by the Corporation to a consulting firm owned by an
officer amounting to $8,133 during the period from January 1, 2005 to March 23,
2005.
   74
  January 1,
2004 to December 31, 2004
  During
the Corporation’s fiscal year ended December 31, 2004, the Corporation
accrued and/or paid legal fees to a law firm of which one of the directors of
the Corporation was a partner amounting, in the aggregate, to
$125,708.
  A
management fee was paid by the Corporation to a consulting firm owned by an
officer amounting to $46,067 during the fiscal year ended December 31,
2004.
  A
management fee was paid by the Corporation to a consulting firm owned by a
director amounting to $30,000 during the fiscal year ended December 31,
2004.
  ***C.*** ***Interests
of Experts and Counsel***
  Not
applicable.
  **Item 8
-** **Financial
Information**
  ***A.*** ***Consolidated
Statements and Other Financial Information***
  See *Item 18 -
Financial Statements* .
  Legal
Proceedings
  To our
knowledge, the material legal proceedings related to the Company are as
follows:
  Certain
of our customers have been subject to a patent infringement claim in the
People’s Republic of China as described below **.** While we
have not been made party to the claims, these customers have executed licenses
with the Company for the use of eZiText on their products, which licenses
contain third party intellectual property infringement indemnities. As a result,
these claims may have significant consequences for the Company to the extent
that such claims may relate to the implementation and use of eZiText on products
sold in the People’s Republic of China and to the extent that our indemnity
under our license agreement may be applicable.
  *(i)*
    *Dalian
      Hanpu Applied Technology Co., Ltd., Hu Xianhua & Hu Bin v.
      Ericsson (China) Co., Ltd. and Beijing Ericsson Mobile Telecommunication
      Co., Ltd., (the “First Dalian Ericsson Action”).*The
      First Dalian Ericsson Action is in the Higher People’s Court (the “High
      Court”) in Beijing, China. The Court served Beijing Ericsson Mobile
      Telecommunication Co., Ltd. on August 16, 2000, and Ericsson (China)
      Co., Ltd. with the plaintiffs’ complaint on August 17, 2000. The
      complaint alleges that Ericsson (China) Co. Ltd. and Beijing Ericsson
      Mobile Telecommunication Co., Ltd. infringed the plaintiffs’ intellectual
      property rights, namely Chinese patent ZL96120693.4, “Keyboard Assignment
      of Stroke Input and its Screen Prompt.” On August 18, 2000, Ericsson
      sent Zi Corporation a request for indemnification pursuant to the license
      agreement between Ericsson Mobile Communications AB and Zi Corporation of
      Canada, Inc. The Company and its affiliates have not been named as a party
      in the First Dalian Ericsson Action.
  *(ii)*
    *Dalian
      Hanpu Applied Technology Co., Ltd., Hu Xianhua & Hu Bin v.
      Ericsson (China) Co., Ltd. and Nanjing Ericsson Panda Mobile Terminals
      Co., Ltd., (the “Second Dalian Ericsson (Panda) Action”).*The
      Second Dalian Ericsson (Panda) Action is in the Second Intermediate
      People’s Court (the “Lower Court”) in Beijing, China. This is a lower
      court than the Higher People’s Court in which the First Dalian Ericsson
      Action is being tried. The plaintiffs’ complaint was filed with the Court
      on February 22, 2001. This complaint alleges that Ericsson (China)
      Co., Ltd. and Nanjing Ericsson Panda Mobile Terminals Co., Ltd. infringed
      the plaintiffs’ intellectual property rights, namely Chinese patent
      ZL96120693.4, “Keyboard Assignment of Stroke Input and its Screen Prompt”
      (the same patent under suit in the First Dalian Ericsson Action). On
      February 22, 2001, Ericsson sent Zi Corporation a request for
      indemnification pursuant to the Ericsson Chinese License Agreement
      (defined below). The Company and its affiliates have not been named as a
      party in the Second Dalian Ericsson (Panda) Action. A ruling in Ericsson’s
      favour was issued by the Lower Court on this matter on May 23, 2002.
      The Lower Court rejected the plaintiff’s claims of infringement finding
      that: (1) there was no literal infringement of the plaintiff’s patent
      by Zi’s input technology on the Ericsson phone models in dispute; and
      (2) the doctrine of equivalence argued by the plaintiff could not be
      accepted as it would broaden the original scope of the plaintiff’s patent
      claims. The plaintiff was charged with paying a nominal amount of RMB1000
      to cover case handling fees. The plaintiff has filed a notice of appeal to
      the High Court in order to appeal this Lower Court ruling. Ericsson is
      actively defending this appeal.
   75
 
 Both
claims described in (i) and (ii) above will be collectively referred to as the
“Ericsson/HuBin Claims” and the Ericsson parties named in the Ericsson/HuBin
Claims shall be referred to as “Ericsson”. Under the respective notices sent to
us, Ericsson asserted its rights to indemnification granted by us to Ericsson
under our Chinese eZiText license agreement with Ericsson signed
February 17, 1998 (the “Ericsson Chinese License Agreement”). Pending
determination of the actual scope of the alleged infringement and whether the
scope of indemnity provided under the Ericsson Chinese License Agreement
applies, we have taken a course of action where we pay for Ericsson’s legal fees
and where we exercise sole control of the conduct of Ericsson’s defense against
the Ericsson/HuBin Claims. Ericsson is actively cooperating and participating
with Zi to defend against the Ericsson/HuBin Claims. We believe that the
allegations are unfounded and without merit and Zi and Ericsson are vigorously
defending against the Hu Bin claims.
  To date,
the two cases remain in the hands of the Beijing High People’s Court. Ericsson
has requested a schedule from the Beijing High People’s Court. The Company is
not aware of any response from Beijing High People’s Court to Ericsson’s request
for a timetable or any other actions taken by any of the parties involved in
this matter.
  Furthermore,
Ericsson made a separate application to the PRC Patent Office seeking
invalidation of the HuBin Patent. An invalidation hearing was held with the PRC
Patent Re-examination Board on May 27, 2002. In March 2004, a ruling from
the PRC Patent Re-examination Board was rendered in favour of the patent. An
appeal was heard in October 2004 and Ericsson was successful on most counts. As
a result, certain portions of the Hu Bin patent were found to be invalid. We are
awaiting advice with respect to the status of this matter.
  *(iii)*
    *Dalian
      Hanpu Applied Technology Co., Ltd., Hu Xianhua & Hu Bin v.
      Alcatel Suzhou communication Co., Ltd and Another (the “Dalian Alcatel
      Action”).*The
      Dalian Alcatel Action is also in the Lower Court. On April 5, 2001,
      the Company received a notice from Alcatel Suzhou Communication Co., Ltd.
      that Alcatel Suzhou Communication Co., Ltd, and Yanshaqiro Trading Branch
      of Beijing Yingcong Science and Trade Center have been made parties to a
      patent infringement claim in the PRC (the “Alcatel/Hu Bin Claims”) filed
      in the Lower Court for infringement of Chinese patent ZL96120693.4 (the
      same patent in both of the First Dalian Ericsson Action and the Second
      Dalian Ericsson (Panda) Action). On April 19, 2001 Alcatel sent Zi
      Corporation of Canada, Inc. a request for indemnification pursuant to the
      license agreement between Alcatel Business Systems and Zi Corporation of
      Canada, Inc. Zi responded denying the applicability of the indemnity and
      we have not received any answering response from Alcatel. The Company and
      its affiliates have not been named as a party in the Dalian Alcatel
      Action.
   76
 
 A ruling
in Alcatel’s favour on this matter was also issued by the Lower Court on
May 23, 2002. The rulings by the Lower Court in this Dalian Alcatel Action
are substantially similar to those given in the Second Dalian Ericsson (Panda)
Action. The plaintiff has filed a notice of appeal to the High Court in order to
appeal this Lower Court ruling. Alcatel is actively defending this
appeal.
  We have
disputed the applicability of the indemnity provided by us to Alcatel under the
license agreement dated October 20, 1999 (the “Alcatel License Agreement”)
in respect of the Alcatel/HuBin Claims. To date, we are not providing any
indemnification to Alcatel in respect of Alcatel’s defense of the Alcatel/Hu Bin
claim; however, we have been actively providing Alcatel technical support for
their defense.
  *(iv)*
    *Zi
      Corporation, an Alberta, Canada corporation, and Zi Corporation of
      America, Inc., a Nevada corporation v. Morrison & Foerster
      LLP*,*a
      limited liability partnership, and Does 1-100*,
      inclusive (the” MoFo” Malpractice Action). An action against Morrison
      & Foerster LLP was commenced on behalf of the Company by its
      litigation counsel, Foley Bezek, LLP (“F&B”), in the Superior Court of
      the State of California, County of San Francisco claiming (i) professional
      negligence based on MoFo’s failure to exercise reasonable care, skill and
      diligence in representing the Company in the defence of Asian
      Communication Pty Ltd and Tegic Communications Inc. v. Zi Corporation and
      Zi Corporation of America, Inc. (the Tegic California patent infringement
      lawsuit described more fully at*Item
      3 - Risk Factors - Tegic Lawsuit Settlement*and (ii) reimbursement of the payments made to MoFo in connection with the
      defense of*Tegic
      v. Zi Corporation*,
      which payments are alleged to exceed the reasonable value of MoFo’s
      services and costs advanced. MoFo has filed, as part of its defence to the
      Company’s action, a cross complaint against Zi Corporation for payment of
      legal fees incurred and reimbursement of out-of-pocket costs advanced in
      the defence of*Tegic
      v. Zi Corporation*(in addition to legal fees and costs already paid by the Company to MoFo
      in the amount of US$1,061,616.81). The likelihood of net gain or loss on
      the complaint by Zi Corporation against MoFo and the cross-complaint by
      MoFo against the Company is not determinable at this
  time.
 
 Dividend
Policy
  To date,
we have not paid any dividends on shares, and do not anticipate doing so in the
foreseeable future. The declaration of dividends on our common shares is within
the discretion of our board of directors and will depend upon, among other
factors, earnings, capital requirements, and the operating and financial
condition of the Company.
   77
  ***B.*** ***Significant
Changes***
  Not
applicable
  **Item 9
-** **The
Offer and Listing**
  ***A.*** ***Offer
and Listing Details - Stock Price History***
  Our
common shares are traded on the Toronto Stock Exchange under the symbol “ZIC”
and on the NASDAQ National Market under the symbol “ZICA”. The following tables
set forth, for the periods indicated, high and low sale prices of our common
shares as reported on the Toronto Stock Exchange and on the NASDAQ National
Market.
   78
  **Toronto
Stock Exchange (in CDN$):**
  **Period**
    
    **High**
    
    **Low**February
      2005
    
    $
    9.15
    
    $
    6.65January
      2005
    
    $
    7.85
    
    $
    6.30December
      2004
    
    $
    8.69
    
    $
    3.56November
      2004
    
    $
    4.66
    
    $
    3.23October
      2004
    
    $
    5.20
    
    $
    4.03September
      2004
    
    $
    4.26
    
    $
    2.57Quarter
      ended December 31, 2004
    
    $
    8.69
    
    $
    3.23Quarter
      ended September 30, 2004
    
    $
    4.26
    
    $
    2.57Quarter
      ended June 30, 2004
    
    $
    3.85
    
    $
    2.78Quarter
      ended March 31, 2004
    
    $
    4.03
    
    $
    3.17Quarter
      ended December 31, 2003
    
    $
    4.20
    
    $
    2.95Quarter
      ended September 30, 2003
    
    $
    5.60
    
    $
    2.88Quarter
      ended June 30, 2003
    
    $
    5.09
    
    $
    2.39Quarter
      ended March 31, 2003
    
    $
    5.48
    
    $
    2.75Year
      ended December 31, 2004
    
    $
    8.69
    
    $
    2.57Year
      ended December 31, 2003
    
    $
    5.60
    
    $
    2.39Year
      ended December 31, 2002
    
    $
    11.29
    
    $
    2.35Year
      ended December 31, 2001
    
    $
    14.50
    
    $
    7.36Year
      ended December 31, 2000
    
    $
    59.25
    
    $
    4.75
   **NASDAQ
(in US$):**
 **Period**
    
    **High**
    
    **Low**February
      2005
    
    $
    7.45
    
    $
    5.41January
      2005
    
    $
    6.89
    
    $
    5.10December
      2004
    
    $
    7.55
    
    $
    3.00November
      2004
    
    $
    3.84
    
    $
    2.65October
      2004
    
    $
    4.13
    
    $
    3.28September
      2004
    
    $
    3.35
    
    $
    2.02Quarter
      ended December 31, 2004
    
    $
    7.55
    
    $
    2.65Quarter
      ended September 30, 2004
    
    $
    3.35
    
    $
    2.00
  Quarter
      ended June 30, 2004
    
    $
    2.89
    
    $
    2.03Quarter
      ended March 31, 2004
    
    $
    3.05
    
    $
    2.42Quarter
      ended December 31, 2003
    
    $
    3.11
    
    $
    2.25Quarter
      ended September 30, 2003
    
    $
    4.08
    
    $
    2.11Quarter
      ended June 30, 2003
    
    $
    3.82
    
    $
    1.62Quarter
      ended March 31, 2003
    
    $
    3.47
    
    $
    1.82Year
      ended December 31, 2004
    
    $
    7.55
    
    $
    2.00Year
      ended December 31, 2003
    
    $
    4.08
    
    $
    1.62Year
      ended December 31, 2002
    
    $
    7.04
    
    $
    2.27Year
      ended December 31, 2001
    
    $
    9.44
    
    $
    4.00Year
      ended December 31, 2000
    
    $
    40.88
    
    $
    3.13
   79
  ***B.*** ***Plan
of Distribution***
  Not
applicable.
  ***C.*** ***Markets***
  Our
common shares are listed on the Toronto Stock Exchange and NASDAQ National
Market Exchange. At December 31, 2004, the Company had
45,225,190 common shares outstanding, with no par value.
  ***D.*** ***Selling
Shareholders***
  Not
applicable.
  ***E.*** ***Dilution***
  Not
applicable.
  ***F.*** ***Expenses
of the Issue***
  Not
applicable.
  **Item 10
-** **Additional
Information**
  ***A.*** ***Share
Capital***
  Not
applicable.
  ***B.*** ***Memorandum
and Articles of Association***
  The
Company’s Certificate of Incorporation, together with all amendments, which we
refer to as our articles of incorporation, are on file with the Alberta
Registrar of Corporations under Alberta Corporate Access Number 203761614. Our
articles of incorporation do not include a stated purpose and contain no
restrictions on the nature of business to be carried on. Under the Alberta *Business
Corporations Act* , in the
absence of any such restrictions, a corporation has the capacity, rights, powers
and privileges of a natural person, and has the capacity to carry on business,
conduct its affairs and exercise its power in any jurisdiction outside Alberta
to the extent that the laws of that jurisdiction permit. For additional
information regarding our incorporation, see *Item 4 -
Information on the Company - History and Development of the
Company* .
   80
  *Directors*
  A
director of our Company need not be a shareholder. In accordance with the
Alberta *Business
Corporations Act* , at
least half of our directors must be residents of Canada. The Alberta *Business
Corporations Act* requires
that a person must be at least 18 years of age, be of sound mind and not be
bankrupt or a dependent adult or formal patient under the *Dependent
Adults Act* or *Mental
Health Act* , or the
subject of an order under *The
Mentally Incapacitated Persons Act* in order
to serve as a director. Neither our articles of incorporation or by-laws, nor
the Alberta *Business
Corporations Act* , impose
any mandatory retirement requirements for directors.
  A
majority of the lesser of the number of directors holding office at the time of
the meeting and the minimum number of directors required by our articles of
incorporation will constitute a quorum, provided that at least half of the
directors present are resident Canadians. Business cannot be transacted at a
directors’ meeting without quorum.
  A
director who is a party to, or who is a director or officer of or has a material
interest in any person who is a party to, a material contract or transaction or
proposed material contract or transaction with our Company shall disclose to the
Company the nature and extent of his interest at the time and in the manner
provided by the Alberta *Business
Corporations Act* . The
Alberta *Business
Corporations Act* prohibits such a director from voting on any resolution to approve the contract
or transaction unless the contract or transaction:
  §
    is
      an arrangement by way of security for money lent to or obligations
      undertaken by the director for the benefit of the Company or an
      affiliate;
 §
    relates
      primarily to his or her remuneration as a director, officer, employee or
      agent of the Company or an affiliate;
 §
    is
      for indemnity or insurance; or
 §
    is
      with an affiliate.
 
 Our board
of directors may, on behalf of the Company and without authorization of our
shareholders:
  §
    borrow
      money upon the credit of the company;
 §
    issue,
      reissue, sell or pledge bonds, debentures, notes or other evidences or
      indebtedness or guarantees of our company, either secured or
      unsecured;
 §
    subject
      to certain disclosure requirements of the Alberta*Business
      Corporations Act*,
      give a guarantee on behalf of our Company to secure performance of an
      obligation of any person;
 §
    mortgage,
      hypothecate, pledge or otherwise create a security interest in all or any
      property of the Company owned or subsequently acquired to secure any
      obligation of the Company; and
 §
    issue
      common shares or other securities of the
Company.
 
 Our
articles of incorporation permit our Board of Directors to appoint one or more
additional directors of the Company to serve until the next annual meeting of
shareholders, provided that the number of additional directors does not at any
time, exceed one-third of the number of directors who held office at the
expiration of the last annual meeting of shareholders of the
Company.
  *Common
Shares*
  Our
articles of incorporation authorize the issuance of an unlimited number of
common shares. The holders of the common shares of the Company are entitled to
receive notice of and to attend all meetings of the shareholders of our Company
and have one vote for each common share held at all meetings of the shareholders
of the Company, except for meetings at which only holders of another specified
class or series of shares of the Company are entitled to vote separately as a
class or series.
   81
  Subject
to the prior rights of the holders of preferred shares of the Company, the
holders of common shares are entitled to received dividends if and when declared
by our board of directors.
  In the
event of the dissolution, liquidation or winding-up of the Company and subject
to the prior rights of the holders of preferred shares, the holders of the
common shares will be entitled to share equally in the remaining property and
assets of the Company.
  *Preferred
Shares*
  Our
articles of incorporation authorize the issuance of an unlimited number of
preferred shares, in one or more series. The Alberta *Business
Corporations Act* does not
impose restrictions upon our board of directors issuing preferred shares of the
type authorized by our articles of incorporation. Our board of directors may
fix, before issuing, the number of preferred shares of each series, the
designation, rights, privileges, restrictions and conditions attaching to the
preferred shares of each series, including the rate or amount of dividends or
the method of calculating dividends, the dates of payment of dividends, the
redemption purchase and/or conversion price and terms and conditions of
redemption, purchase and/or conversion and any sinking fund or other provisions,
the whole to be subject to the sending of articles of amendment in prescribed
form and the issuance of a certificate of amendment.
  Our
articles of incorporation require that preferred shares of each series must,
with respect to the payment of dividends and the distribution of assets in the
event of the liquidation, dissolution or winding-up of the Company, whether
voluntary or involuntary, or any other return of capital or distribution of the
assets of the Company among its shareholders for the purpose of winding up our
affairs, rank on a parity with the preferred shares of every other series and be
entitled to preference over the common shares and over any other shares of the
Company ranking junior to the preferred shares.
  If any
cumulative dividends or amounts payable on the return of capital in respect of a
series of preferred shares are not paid in full, all series of preferred shares
shall participate rateably in respect of accumulated dividends and return of
capital.
  The
holders of preferred shares will not be entitled to receive notice of or vote at
any shareholders’ meetings, except as specifically provided by the Alberta *Business
Corporations Act* . No
preferred shares are currently outstanding. There is no present intention to
issue any preferred chares.
  *Changing
Rights of Shareholders*
  We are
required to amend our articles of incorporation to effect any change to the
rights of our shareholders. Such an amendment would require the approval of
holders of two-thirds of the shares cast at a duly called special meeting. If we
wish to amend the rights of holders of a specific class of shares, such approval
would also be required from the holders of that class. A shareholder is entitled
to dissent in respect of such a resolution and, if the resolution is adopted and
the Company implements such changes, demand payment of the fair value of its
shares.
   82
  *Shareholder
Meetings*
  An annual
meeting of shareholders is held each year, not later than 15 months after
the last preceding annual meeting, for the purpose of considering the financial
statements and reports, electing directors, appointing auditors and for the
transaction of other business as may be brought before the meeting. The board of
directors has the power to call a special meeting of shareholders at any time.
The By-laws of the Company provide that two persons present in person holding or
representing by proxy five (5%) percent of the issued Common Shares of the
Corporation, shall constitute a quorum for the meeting in respect of holders of
Common Shares. Although this quorum requirement is less than that imposed by the
rules of the NASDAQ National Market System, we have operated for the past two
years under an exemption from such requirement on the basis that we are a
foreign private issuer and such a quorum requirement is consistent with normal
business practices in our jurisdiction of incorporation.
  Notice of
the time and place of each meeting of shareholders must be given not less than
21 days, nor more than 50 days, before the date of each meeting to
each director, to the auditor and to each shareholder who at the close of the
business on the record date for notice is entered in the securities register as
the holder of one or more shares carrying the right to vote at the meeting.
Notice of meeting of shareholders called for any other purpose other than
consideration of the minutes of an earlier meeting, financial statements and
auditor’s report, election of directors and reappointment of the incumbent
auditor, must state the nature of the business in sufficient detail to permit
the shareholder to form a reasoned judgement and must state the text of any
special resolution to be submitted to the meeting.
  The only
persons entitled to be present at a meeting of shareholders are those entitled
to vote, the directors of the company and the auditor of the company. Any other
person may be admitted only on the invitation of the chairman of the meeting or
with the consent of the meeting. If a corporation is winding-up, the Alberta *Business
Corporations Act* permits
a liquidator appointed by the shareholders, during the continuance of a
voluntary winding-up, to call and attend meetings of the shareholders. In
circumstances where a court orders a meeting of shareholders, the court may
direct how the meeting may be held, including the parties entitled, or required,
to attend the meeting.
  Our
articles of incorporation states that meetings of our shareholders may be held
in the cities of San Francisco, California, Los Angeles, California, New York,
New York and Phoenix, Arizona in the United States of America, in Toronto,
Ontario, Canada and in Hong Kong, China and Beijing, China in addition to
anywhere in the Province of Alberta.
  *Limitations
on Right to Own Securities*
  There is
no limitation imposed by Canadian law or by our articles or other charter
documents on the right of a non-resident to hold or vote common shares or
preference shares with voting rights (the “Voting Shares”), other than as
provided in the *Investment
Canada Act* (the
“ICA”). The ICA requires a non-Canadian making an investment which would result
in the acquisition of control of a Canadian business (i.e. the gross value of
the assets of which exceed a certain monetary threshold) to identify, notify, or
file an application for review with the Investment Review Division of Industry
Canada (“IRD”).
  The
notification procedure involves a brief statement of information about the
investment on a prescribed form which is required to be filed with the IRD by
the investor at any time up to 30 days following implementation of the
investment. It is intended that investments requiring only notification will
proceed without government intervention unless the investment is in a specific
type of business activity related to Canada’s cultural heritage and national
identity.
   83
  If an
investment is reviewable under the ICA, an application for review in the form
prescribed is normally required to be filed with the IRD prior to the investment
taking place and the investment may not be implemented until the review has been
completed and the Minister of Industry (“Minister”) (the Minister responsible
for Investment Canada) is satisfied that the investment is likely to be of net
benefit to Canada. The Minister has up to 75 days to make this
determination. If the Minister is not satisfied that the investment is likely to
be of net benefit to Canada, the non-Canadian must not implement the investment
or, if the investment has been implemented, may be required to divest himself of
control of the business that is the subject of the investment.
  In 1999,
some of the powers, duties and functions of the Minister were transferred to the
Minister of Canadian Heritage under Parts II to VI of the ICA as they
relate to the prescribed business activities enumerated under
paragraph 15(a) of the ICA, namely those that relate to Canada’s “cultural
heritage or national identity” (Cultural Activities”) Cultural Activities
include, among other things, the distribution or sale of books, magazines, film
and video recordings and music recordings. As a result, an application for
review must be submitted to the Cultural Sector Review Division of the
Department of Canadian Heritage (the “CSRD”) in respect of the acquisition of
control of a Canadian business engaged in a Cultural Activity that exceeds the
prescribed lower monetary threshold applicable to the acquisition of such
Canadian businesses.
  The
Minister of Canadian Heritage’s review, similar to the Minister’s review, is
based on the statutory threshold of net benefit to Canada. CSRD is guided by
certain policy statements regarding investments by non-Canadians in Canadian
businesses engaged in certain Cultural Activities. CSRD’s policy statements
address certain Cultural Activities at the production/publication, distribution
and/or exhibition levels.
  The
following investments by non-Canadians are subject to notification under the
ICA:
  1.
    An
      investment to establish a new Canadian business;
and
  2.
    An
      investment to acquire control of a Canadian business that is not
      reviewable pursuant to the Act.
  The
following investments by a non-Canadian are subject to review under the
ICA:
  1.
    An
      investment is reviewable if there is an acquisition of a Canadian business
      and the asset value of the Canadian business being acquired equals or
      exceeds the following thresholds:
  (a)
    For
      non-World Trade Organization (“WTO”) investors, the threshold is
      CDN$5 million for a direct acquisition and CDN$50 million for an
      indirect acquisition; the CDN$5 million threshold will apply however
      for an indirect acquisition if the asset value of the Canadian business
      being acquired exceeds 50% of the asset value of the global
      transaction;
  (b)
    Except
      as specified in paragraph (c) below, a threshold is calculated
      annually for reviewable direct acquisitions by or from WTO investors. The
      threshold for 2005 is CDN$250 million. Pursuant to Canada’s
      international commitments, indirect acquisitions by or from WTO investors
      are not reviewable;
   84
  (c)
    The
      limits set out in paragraph (a) apply to all investors for
      acquisitions of a Canadian business that:
  (i)
    engages
      in the production of uranium and owns an interest in a producing uranium
      property in Canada;
  (ii)
    provides
      any financial service;
  (iii)
    provides
      any transportation services; or
  (iv)
    is
      a cultural business.
  2.
    Notwithstanding
      the above, any investment which is usually only notifiable, including the
      establishment of a new Canadian business, and which falls within a
      specific business activity, including the publication and distribution of
      books, magazines, newspapers, film or video recordings, audio or video
      music recordings, or music in print or machine-readable form may be
      reviewed if an Order-in-Council directing a review is made and a notice is
      sent to the Investor within 21 days following the receipt of a
      certified complete notification.
  Generally
speaking, an acquisition is direct if it involves the acquisition of control of
the Canadian business or of its direct or indirect Canadian parent and an
acquisition is indirect if it involves the acquisition of control of a
non-Canadian direct or indirect parent of an entity carrying on the Canadian
business. No change of voting control will be deemed to have occurred if less
than one-third of the voting control of a Canadian corporation is acquired by an
investor.
  A WTO
investor, as defined in the ICA, includes an individual who is a national of a
member country of the WTO or who has the right of permanent residence in
relation that WTO member, a government or government agency of a WTO
investor-controlled corporation, a limited partnership, trust or joint venture
that is neither WTO-investor controlled or Canadian controlled of which
two-thirds of its board of directors, general partners or trustees, as the case
may be, are any combination of Canadians and WTO investors.
  The
higher thresholds for WTO investors do not apply if the Canadian business
engages in activities in certain sectors such as uranium, financial services
(except insurance), transportation services or cultural business.
  The ICA
exempts certain transactions from the notification and review provisions of ICA,
including, among others, (a) an acquisition of Voting Shares if the
acquisition were made in the ordinary course of that persons’ business as a
trader or dealer in securities; (b) an acquisition of control of the
company in connection with the realization of a security interest granted for a
loan or other financial assistance and not for any purpose related to the
provisions of the ICA; (c) the acquisition of voting interests by any
person in the ordinary course of a business carried on by that person that
consists of providing, in Canada, venture capital on terms and conditions not
inconsistent with such terms and conditions as may be fixed by the Minister; and
(d) acquisition of control of the Company by reason of an amalgamation,
merger, consolidation or corporate reorganization, following which the ultimate
direct or indirect control in fact of the Company, through the ownership of
voting interests, remains unchanged.
   85
  *Change
of Control*
  Our
articles of incorporation and by-laws do not contain any specific provision that
has the effect of delaying, deferring or preventing a change of control of our
company.
  Our
authorized capital consists of an unlimited number of common shares and an
unlimited number of preferred shares. Although we have not issued any preferred
shares to date, the board of directors, may without any further vote by the
common shareholders, issue preferred shares and determine the price,
preferences, rights and restrictions, including voting and dividend rights, of
these shares. The rights of the holders of common shares are subject to the
rights of holders of any preferred shares that the Board of Directors may issue
in the future. That means that we can, for example, issue preferred shares with
more voting rights, higher dividend payments or more favourable rights upon
dissolution, than the common shares. If we issued certain types of preferred
shares in the future, it may also be more difficult for a third-party to acquire
a majority of our outstanding voting shares.
  *Disclosure
of Ownership*
  Our
by-laws do not contain provisions regarding public disclosure of share
ownership. Applicable Canadian securities legislation requires certain public
disclosure of the shareholdings of those persons who are insiders of the
Company. Insiders include directors and senior officers as well as those persons
who own common shares that exceed 10 percent of our company’s total issued
and outstanding common shares.
  ***C.*** ***Material
Contracts***
  In the
past two years the Company has not entered into any material contract (other
than contracts entered into in the ordinary course of business) except for the
following:
  1.
    Settlement
      Agreement with AOL - See*Item 3 -
      Risk Factors - Risks Related to Settlement of the Tegic
      Lawsuit*and Exhibit 4.17. Settlement Agreement made December 6, 2002
      between America Online, Inc., Zi Corporation and Zi Corporation of
      America, Inc.
  2.
    Consent
      Judgement Order and Permanent Injunction dated December 20, 2002 made
      by The Honourable Maxine M. Chesney, United States District Court
      Judge in the United States District Court for the Northern District of
      California San Francisco Division.
  3.
    Employment
      Agreement dated July 23, 2003, between Zi Corporation and Mike
      Donnell.
  4.
    Form
      of Subscription Agreement pursuant to a $2,000,000****private
      placement of 1,000,000 units at $2.00 per unit, each unit consisting
      of one common share and one-half of one common share purchase warrant.
      Each full warrant entitles the holder to acquire one additional common
      share until May 31, 2006 upon payment of $2.25. The private placement was
      completed on June 19, 2003
(1,000,000 units).
  5.
    Amending
      Agreement dated March 31, 2004, (re Employment Agreement dated December
      31, 1999, between Zi Corporation and Michael
Lobsinger).
  See also
the exhibits to this Annual Report.
   86
  The
Company has also entered into employment agreements with certain executive
officers of the Company. See *Item 6 -
Directors - Senior Management and Employees* .
  ***D.*** ***Exchange
Controls*** ******
  The
Company is aware of no governmental laws, decrees or regulations, including
foreign exchange controls, in Canada which restrict the export or import of
capital or that affect the remittance of dividends, interest or other payments
to non-resident holders of the Company’s securities. Any such remittances to
United States residents, however, are subject to a withholding tax pursuant to *The
Canada - US Income Tax Convention* (1980),
as amended.
  The
Company knows of no limitations under the laws of Canada, the Province of
Alberta, or in the charter or any other constituent documents of the Company
imposed on the right of foreigners to hold or vote the shares of the
Company.
  Except as
provided in the ICA, the Company knows of no limitations under the laws of
Canada, the Province of Alberta, or in the charter or any other constituent
documents of the Company imposed on the right of foreigners to hold or vote the
shares of the Company. See *Item 10 -
Additional Information - Limitations on Rights to Own
Securities* .
  ***E.*** ***Taxation*** ******
  Material
Canadian Income Tax Consequences
  Generally,
cash dividends paid by Canadian corporations to non-resident shareholders are
subject to a withholding tax of 25 percent. However, the *Canada -
US Income Tax Convention* (1980),
as amended (“the Convention”), provides for a 15 percent withholding tax on
dividends paid to all individuals and corporate residents of the United States
qualifying for treaty benefits. Dividends paid to any non-resident company that
beneficially owns at least 10 percent of the voting stock of the payer
company are subject to withholding tax at 5 percent.
  A
non-resident shareholder who holds shares of the Company as capital property
will not be subject to tax on capital gains realized on the disposition of such
shares unless such shares are “taxable Canadian property” within the meaning of
the *Income
Tax Act* (Canada)
and no relief is afforded under any applicable tax treaty. The shares of the
Company would be taxable Canadian property of a non-resident shareholder if the
non-resident shareholder used the shares in carrying on a business in Canada.
The shares of the Company would also be taxable Canadian property of a
non-resident shareholder if at any time during the five year period immediately
preceding the disposition, not less than 25 percent of the issued shares of
any class of the Company belonged to the particular shareholder or persons with
whom the shareholder did not deal at arms length.
  Material
United States Federal Income Tax Consequences
  The
following is a general discussion of material United States federal income tax
consequences, under current law, generally applicable to a US Holder (as defined
below) of the Company’s common shares. This discussion does not address all
potentially relevant federal income tax matters and it does not address
consequences peculiar to persons subject to special provisions of federal income
tax law, such as those described below as excluded from the definition of a US
Holder. In addition, this discussion does not cover any state, local or foreign
tax consequences. See “ *Certain
Canadian Income Tax Consequences* ”
above.
   87
  The
following discussion is based upon the  *Internal
Revenue Code of 1986* , as
amended to the date hereof (the “Code”), existing and proposed Treasury
Regulations, published Internal Revenue Service (“IRS”) rulings, published
administrative positions of the IRS and court decisions that are currently
applicable, any or all of which could be materially and adversely changed,
possibly on a retroactive basis, at any time. This discussion does not consider
the potential effects, both adverse and beneficial, of any recently proposed
legislation which, if enacted, could be applied, possibly on a retroactive
basis, at any time.
  **This
discussion is of a general nature only and is not exhaustive of all US federal
income tax implications, and it is not intended to be, nor should it be
construed to be, legal or tax advice to any particular holder or prospective
holder of the Company’s common shares and no opinion or representation with
respect to the United States federal income tax consequences to any such holder
or prospective holders is made. Accordingly, holders and prospective holders of
the Company’s common shares should consult their own tax advisors about the
federal, state, local, and foreign tax consequences of purchasing, owning and
disposing of the Company’s common shares.**
  US
Holders
  As used
herein, a “US Holder” means a holder of the Company’s common shares who is a US
citizen or individual income tax resident of the United States under US domestic
law and the Convention, a corporation created or organized in or under the laws
of the United States or of any political subdivision thereof, an estate the
income of which is includable in gross income for US federal income tax purposes
regardless of its source or a trust if a US court is able to exercise primary
supervision over the trust’s administration and one or more US persons have
authority to control all substantial decisions of such trust. This summary does
not address the tax consequences to, and a US Holder does not include, persons
subject to special provisions of federal income tax law, including
but not limited to  tax-exempt
organizations, qualified retirement plans, individual retirement accounts and
other tax-deferred accounts, financial institutions, insurance companies, real
estate investment trusts, regulated investment companies, broker-dealers,
non-resident alien individuals, persons or entities that have a “functional
currency” other than the US dollar, shareholders who hold common stock as part
of a “straddle”, hedging or a conversion transaction and shareholders who
acquired their stock through the exercise of employee stock options or otherwise
as compensation for service. This discussion is limited to US Holders who hold
the common shares as capital assets and who
hold the common shares directly (e.g., not through an intermediate entity such
as a corporation, partnership, LLC or trust) . This
discussion does not address the consequences to a person or entity holding an
interest in a US Holder or the consequence to a person of the ownership,
exercise or disposition of any warrants, options or other rights to acquire
common shares.
  Distributions
on Common Shares
  US
Holders receiving dividend distributions with
respect to the Company’s common shares are required to include in gross income
for United States federal income tax purposes the gross amount of such
distributions (including
any Canadian tax withheld) equal to
the US dollar value of each dividend on the date of receipt (based on the
exchange rate on such date) to the extent that the Company has current or
accumulated earnings and profits, without reduction for any Canadian income tax
withheld from such distributions. It should be noted that as used in this
discussion of US Federal Income Tax Consequences, the term “earnings and
profits” refers to the Company’s earnings and profits as determined under the Code and the
term “dividend” refers to corporate distributions taxable as dividends for US
federal income tax purposes . Such
Canadian tax withheld may be credited, subject to certain limitations, against
the US Holder’s United States federal income tax liability or, alternatively,
may be deducted in computing the US Holder’s United States federal taxable
income by those who itemize deductions. (See more detailed discussion at
“ *Foreign
Tax Credit* ” below.)
To the extent that distributions exceed current or accumulated earnings and
profits of the Company, they will be treated first as a return of capital up to
the US Holder’s adjusted basis in the common shares and thereafter as gain from
the sale or exchange of the common shares. Preferential tax rates for long-term
capital gains are applicable to a US Holder which is an individual, estate or
trust. There are currently no preferential tax rates for long-term capital gains
for a US Holder which is a corporation . Dividends
paid on the Company’s common shares generally
will not be
eligible for the dividends received deduction provided to corporations receiving
dividends from certain United States corporations .
   88
  In the
case of foreign currency received as a dividend that is not converted by the
recipient into US dollars on the date of the receipt, a US Holder will have a
tax basis in the foreign currency equal to its US dollar value on the date of
receipt. Generally, any gain or loss recognized upon a subsequent sale or other
disposition of the foreign currency, including an exchange for US dollars, will
be ordinary income or loss . Under
Treasury Regulations, dividends paid on the Company’s common shares, if any,
generally will not be subject to backup
withholding tax (at a
28% rate) if the paying
agent is furnished with a duly completed and signed Form W- 9 or
certain other circumstances apply . Any
amounts withheld under the US backup withholding tax rules will be allowed as a
refund or a credit against the US Holder’s US federal income tax liability,
provided the required information is furnished to the IRS.
  Foreign
Tax Credit
  A US
Holder who pays (or has withheld from distributions) Canadian income tax with
respect to the ownership of the Company’s common shares may be entitled, at the
option of the US Holder, to either a deduction or a tax credit for such foreign
tax paid or withheld. Generally, it will be more advantageous to claim a credit
because a credit reduces United States federal income taxes on a
dollar-for-dollar basis, while a deduction merely reduces the taxpayer’s income
subject to tax. This election is made on a year-by-year basis and generally
applies to all foreign taxes paid by (or withheld from) the US Holder during
that year.
  The
operation of the
foreign tax credit for any
particular US Holder will be dependent on his or its particular
situation . There are
significant and complex limitations which apply to the credit, among which is
the general limitation that the credit cannot exceed the proportionate share of
the US Holder’s United States income tax liability that the US Holder’s foreign
source income bears to his ,
her or its
worldwide taxable income. In the determination of the application of this
limitation, the various items of income and deduction must be classified into
foreign and domestic sources. Complex rules govern this classification process.
In addition, this limitation is calculated separately with respect to specific
classes of income such as “passive income,” “high withholding tax interest,”
“financial services income,” “shipping income,” and certain other
classifications of income. Dividends distributed by the Company will generally
constitute “passive income” or, in the case of certain US Holders, “financial
services income” for these purposes.
  Disposition
of Common Shares
  A US
Holder will recognize gain or loss upon the sale or other
disposition of common
shares equal to the difference, if any, between (i) the amount of cash plus
the fair market value of any property received, and (ii) the shareholder’s
tax basis in the Company’s common shares. Preferential tax rates apply to
long-term capital gains of US Holders who are individuals, estates or
trusts . At
present, there are no preferential tax rates applicable to US Holders which are
corporations . This gain
or loss generally will be
capital gain or loss if the common shares are a capital asset in the hands of
the US Holder, which will be a long-term capital gain or loss if the common
shares of the Company are held for more than one year . Deductions
for net capital losses may be carried over to be used in later tax years until
such net capital loss is thereby exhausted. For US Holders which are
corporations (other than corporations subject to Subchapter S of the Code), an
unused net capital loss may be carried back three years from the loss year and
carried forward five years from the loss year to be offset against capital gains
until such net capital loss is thereby exhausted.
   89
  Other
Considerations
  In the
following circumstances, the above sections of this discussion may not describe
the United States federal income tax consequences resulting from the holding and
disposition of common shares.
  As used
herein “US Person” means a citizen or income tax resident of the United States
as determined under US domestic law.
  Foreign
Personal Holding Company
  If at any
time during a taxable year more than 50 percent of the total combined
voting power or the total value of the Company’s outstanding shares is owned,
directly or indirectly (including through attribution) , by five
or fewer US Persons who are
individuals and
60 percent or more of the Company’s gross income for such year was derived
from certain passive sources (e.g., dividends ,
interest, rents, royalties, etc. ), the
Company is a “foreign personal holding company” (“FPHC”). (The 60 percent
test is reduced to 50 percent after the first tax year that the entity
is a FPHC.) In that event, US Holders would be required to include in gross
income for such year their allocable portions of the Company’s undistributed
income.
  Foreign
Investment Company
  If
50 percent or more of the combined voting power or total value of all
classes of the Company’s stock is held, directly or indirectly (including through attribution) , by US
Persons, the
Company is found to be engaged primarily in the business of investing,
reinvesting, or trading in securities, commodities, or any interest therein, and
certain other conditions are met, it is
possible that the Company may be treated as a “foreign investment company” as
defined in Section 1246 of the Code . This
characterization causes all or
part of any gain realized by a US Holder selling or exchanging common shares to
be treated as ordinary income rather
than capital gain.
  Passive
Foreign Investment Company
  As a
foreign corporation with US Holders, the Company could potentially be treated as
a passive foreign investment company (“PFIC”), as defined in Section 1297
of the Code, depending upon the percentage of the Company’s income which is
passive, or the percentage of the Company’s assets which are producing passive income. Generally, US Holders of PFICs are taxed upon receipt
of “ excess
distributions ” which
include (i) gains recognized on the sale or deemed disposition of PFIC
stock, and (ii) distributions made by the PFIC to the extent that the total
distributions received for the tax year exceeds 125% of the average actual
distributions received in the preceding three years. An excess distribution is
allocated rateably to each day in the shareholder’s holding period for the
stock. Amounts allocated to the current year and the pre-PFIC holding period (if
any) are included in gross income as ordinary income. Amounts allocated to the
PFIC period (other than the current year) are subject to tax at the highest US
income tax rate plus an interest charge to
reflect the benefit
of tax deferral .
   90
  However,
if the US Holder makes a timely election to treat a PFIC as a qualified electing
fund (“QEF”) with respect to such shareholder’s interest therein, the
above-described rules generally would not
apply . Instead,
the electing US Holder would include annually in gross
income his , her or
its pro rata
share of the PFIC’s ordinary earnings and net capital gain , regardless of whether such income or gain was
actually distributed. A US Holder making a QEF election can, however, under
certain circumstances elect to defer the payment of United States federal income
tax on such income inclusions subject to an interest charge on the amount of
deferred taxes . In
addition, subject to certain limitations, US Holders owning (actually or
constructively) marketable stock in a PFIC will be permitted to elect to mark
that stock to market annually, rather than be subject to the excess distribution
regime described above. Amounts included in or deducted from income under this
alternative (and actual gains and losses realized upon disposition, subject to
certain limitations) will be treated as ordinary gains or losses.
  Controlled
Foreign Corporation
  If more
than 50 percent of the voting power of all classes of stock or the total
value of the stock of the Company is owned, directly or indirectly (including through attribution) , by US
Persons, each of whom own 10 percent or more of the total combined voting
power of all classes of stock of the Company (“United States Shareholder ”), the
Company is a
“controlled foreign corporation” under the Code.
This classification has many
complex consequences, one of
which is the inclusion of certain income of a CFC in the US Shareholders’
income on a current basis, regardless of distributions. Such US
Shareholders are
generally treated as having received a current distribution out of the CFC’s
Subpart F income (generally,
passive income and certain income generated by transactions between related
parties) and are
also subject to current US tax on their pro rata shares of the CFC’s earnings
invested in US property . In
certain circumstances, a foreign
tax credit may apply
to reduce
the US tax on these amounts. In addition, under Section 1248 of the Code,
gain from the sale or exchange of stock by a holder of common shares who is or
was a United States Shareholder at any
time during the five year period ending with the sale or exchange may
be treated
as ordinary dividend income to the extent of earnings and profits of the Company
attributable to the stock sold or exchanged. If a foreign corporation is both a
PFIC and a CFC, the foreign corporation generally will not
be treated as a PFIC with respect to United States shareholders of the
CFC .
  ***F.*** ***Dividends
and Paying Agents***
  Not
applicable.
  ***G.*** ***Statement
by Experts***
  Not
applicable.
  ***H.*** ***Documents
on Display***
  Public
documents are available for inspection at the Company’s head offices located at
2100, 840 - 7 th Avenue
S.W., Calgary, AB T2P 3G2, and, for certain documents, on the Internet at
www.sedar.com and at www.edgar.com.
   91
  The
Company is subject to the information requirements of the *Securities
Exchange Act of 1934* , as
amended (the “Exchange Act”), and, to the extent required of Canadian companies,
files periodic reports and other information with the Securities and Exchange
Commission. All such reports and information may be read and copied at the
public reference facilities listed below. The Company intends to give its
shareholders annual reports containing audited financial statements and a report
thereon from its independent chartered accountants and quarterly reports for the
first three quarters of each fiscal year containing unaudited interim financial
information.
  Statements
made in this annual report on Form 20-F about the contents of contracts or
other documents are not necessarily complete and we refer Shareholders to the
copy of such contracts or other documents filed as exhibits to this annual
report.
  The
Company’s Securities and Exchange Commission filings, and the exhibits thereto,
are available for inspection and copying at the public reference facilities
maintained by the Securities and Exchange Commission in Judiciary Plaza,
Room 1024, 450 Fifth Street N.W., Washington, D.C., 20549. Copies of
these filings may be obtained from these offices after the payment of prescribed
fees. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for
further information on the public reference rooms. These filings are also
available on the Securities and Exchange Commission’s website at
www.sec.gov.
  The
Company will also provide its shareholders with proxy statements prepared
according to Canadian law. As a Canadian company, the Company is exempt from the
Exchange Act rules about prescribing the furnishing and content of proxy
statements to shareholders and is also exempt from the short-swing profit
recovery and disclosure regime of section 16 of the Exchange
Act.
  ***I.*** ***Subsidiary
Information***
  Not
applicable.
  **Item 11-** **Quantitative
and Qualitative Disclosure About Market Risk**
  ***A.*** ***Financial
Instruments*** ******
  Accounts
receivable, cash equivalents, investment in significantly influenced company,
accounts payable, accrued liabilities, note payable, capital lease obligations
and other deferred costs constitute financial instruments. The carrying values
of these financial instruments approximate their fair value given the relatively
short periods to maturity. The carrying values for these financial instruments
represent their maximum credit risk. The note receivable constitutes a financial
instrument with a fair value that is not determinable due, in part, to the
unrecognized contingent portion of the note (note 3). The investment in
significantly influenced company constitutes a financial instrument with a fair
value that is not determinable due to the unavailability of independent third
party evidence to support a valuation of this investment.
  The
Company maintains substantially all cash and cash equivalents with major
financial institutions. Deposits held with banks may exceed the amounts of
insurance provided on such deposits. Credit risk exposure includes accounts
receivable with customers primarily located in North America, China, Korea, and
Western Europe. The Company performs ongoing credit evaluations of its
customers’ financial condition and, generally, require no collateral from
customers. The Company is exposed to the risks arising from fluctuations in
foreign exchange rates, and the volatility of those rates. The Company does not
use derivative instruments to reduce its exposure to foreign currency exchange
risk.
   92
  *Interest
Rate Risk*
  The
Company does not maintain any market risk sensitive instruments for trading
purposes or instruments entered into for purposes other than trading purposes,
other than maintaining a short term investment portfolio consisting mainly of
term deposits purchased with an average maturity of less than three months.
These securities are subject to interest rate risk and will fall in value if
market interest rates increase. If market interest rates were to increase
immediately and uniformly by 10 percent of their levels at
December 31, 2004, the fair value of the portfolio would decline by an
immaterial amount. The Company generally has the ability to hold its fixed
income investments until maturity and therefore it would not expect its
operating results or cash flows to be affected to any significant degree by the
effect of a sudden change in market interest rates on its investment
portfolio.
  ***B.*** ***Foreign
Currency*** ******
  *Foreign
Exchange Rate Risk*
  The
foreign operations of the Company are translated into US dollars for financial
statement presentation. Consequently, movements in exchange rates may have
significant impact on financial results.
  Substantially
all of the Company’s product revenues are denominated in U.S. dollars while
expenses are denominated in Canadian dollars, Hong Kong dollars, U.S. dollars
and Chinese renminbi. Based on the 2004 distribution of revenues and cash flows,
a one percent change in the Canadian dollar relative to the U.S. dollar is
estimated to affect revenues by $nil and expenses by $65,000 based upon the
exchange rate on December 31, 2004 of CDN$1.202 to the
US$1.00.
  **Item 12**-**** **Description
of Securities Other than Equity Securities**
  Not
applicable.
  **PART
II**
  **Item 13**-**** **Defaults,
Dividend Arrearages and Delinquencies**
  None.
  **Item 14**-**** **Material
Modifications to the Rights of Security Holders and Use of
Proceeds**
  Not
applicable.
  **Item 15**-**** **Controls
and Procedures**
  At
December 31, 2004, the Company identified a “material weakness” in our internal
controls over financial reporting, as defined in public Company Accounting
Oversight Board (“PCAOB”), Auditing Standard No. 2. As defined by the PCAOB, a
material weakness is “a significant deficiency, or a combination of significant
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.” The material weakness related to a failure to properly reflect
stock based compensation expense over the variety of vesting periods of its
stock option grants. In 2003, the determination of the stock based compensation
expense was based on amortization periods that did not best reflect the variety
of vesting periods for the associated stock option grants. Accordingly, the
Company has restated the 2003 stock compensation expense and appropriate related
balances as disclosed in notes 2 and 16 to the Company’s 2004 consolidated
financial statements. The Company plans to design and implement control
procedures to ensure timely and ongoing review is carried out to incorporate
ongoing changes to stock option grants which effect measurement criteria used to
determine stock compensation expense in the second quarter of 2005.
   93
  As of
December 31, 2004, we carried out an evaluation, under the supervision and with
the participation of our principal executive officer and principal financial
officer, of the effectiveness of the design and operation of our disclosure
controls and procedures. Based on this evaluation, with the exception of the
above, our principal executive officer and principal financial officer have
concluded that our disclosure controls and procedures are effective to ensure
that information required to be included in our periodic reports to the
Securities and Exchange Commission is recorded, processed, summarized and
reported in a timely manner.
  During
the fiscal year ended December 31, 2004, there were no changes in the Company’s
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect the Company’s internal control over
financial reporting.
  **Item 16**-**** **[Reserved]**
  **Item
16A - Audit committee financial expert**
  As an
Alberta corporation with operations principally outside of the United States, it
is considered a “foreign private issuer” for the purposes of filings with the
SEC and with the NASDAQ National Market, on which the Company’s common shares
trade in the United States. Under applicable SEC regulations, an issuer must
disclose if it has an “audit committee financial expert” on its audit committee
if it is required to have such an expert by the listing rules applicable to it.
The NASDAQ has adopted rules which will implement the audit committee financial
expert requirement applicable to foreign private issuers such as the Company,
which will be effective on July 15, 2005. Accordingly, the Company is not
presently subject to the audit committee financial expert
requirement.
 
 The Board
of Directors of the Company has appointed Mr. H. Donald Hyde to the audit
committee. Mr. Hyde is a chartered accountant and has had his own practice since
1991. Prior to setting up his own practice, Mr. Hyde was the vice president of
finance and administration for an international oil and gas drilling and service
company. The Board of Directors has determined that Mr. Donald Hyde possesses
the necessary attributes for designation as the Company's audit committee
financial expert and has designated Mr. Hyde as its audit committee financial
expert to the extent that this requirement currently applies to the Company. As
noted previously, the Company has recently converted its reporting from Canadian
GAAP to US GAAP. Mr. Hyde is qualified as an expert in Canadian GAAP and has an
understanding of US GAAP. Management of the Company believes that Mr. Hyde and
the other members of the Audit Committee have the skills, experience and
education that qualify them to carry out their duties as members of the Audit
Committee. Mr. Hyde is independent as defined by the rules of the NASDAQ
National Market System.
   94
 ****
 **Item
16B - Code of Ethics**
   The
Company has adopted a Code of Business Conduct and Ethics that currently applies
to its directors, officers and employees. Copies of the code will be provided to
any person free of charge upon receipt of a written request, sent to our
registered office via mail or fax.
  **Item
16C - Principal Accountant Fees and Services**
  Audit
Fees
  Deloitte
& Touche LLP were the Company’s independent registered chartered accountants
for both 2004 and 2003. Audit fees paid were $95,691 for 2004 and $83,854 for
2003.  Audit
fees relate to the audit of the year end financial statements, reviews of
interim financial statements, and review of SEC filings.
  Audit
Related Fees
  Audit
related fees paid were $3,092 for 2004 and $29,158 for 2003. Audit related fees
paid in 2003 were related to consultations concerning financial accounting and
reporting standards and the accounting for acquisitions and dispositions carried
out by the Company.
  Tax
Fees
  In 2004,
we paid Deloitte & Touche LLP $7,922 for tax related services. In 2003, we
paid Deloitte & Touche LLP $10,777 for tax related services.
  All Other
Fees
  We did
not purchase any other services from Deloitte & Touche LLP in 2004 or
2003.
  Our Audit
Committee has adopted a policy and procedures for the approval of audit and
non-audit services rendered by our independent auditors, Deloitte & Touche
LLP. The policy generally requires the Audit Committee’s approval of the scope
of the engagement of our independent registered chartered accountants on an
individual basis. The policy prohibits retention of the independent registered
chartered accountants to perform the prohibited non-audit functions defined in
Section 201 of the Sarbanes-Oxley Act of 2002 or the rules of the SEC, and also
considers whether proposed services are compatible with the independence of the
registered chartered accountants. Our Audit Committee approved all of the audit
fees, audit-related fees and tax fees from May 2003 onward.
  **Item
16D - Exemption from the Listing Standards for Audit
Committees**
  Not
applicable
 
 **Item
16E - Purchases of Equity Securities by the Issuer and Affiliated
Purchasers**
  Not
applicable
 
 95
 
 **PART
III**
  **Item 17**-**** **Financial
Statements**
  Not
applicable
  **Item 18**-**** **Financial
Statements**
  See
attached
  96
 
 **Item 1** **9**- **Exhibits**
  The list
of exhibits is included following the signature page hereto.
  **SIGNATURE**
  The
Registrant hereby certifies that it meets all of the requirements for filing on
Form 20-F and that it has duly caused this annual report to be signed on
its behalf.
  **ZI
      CORPORATION**Per:
    /s/ *Dale
  Kearns*Dale KearnsChief Financial
  OfficerDate:March
      31, 2005
 ****
 ****
  ****Per:
    /s/ *Michael
    Donnell*Michael DonnellPresident & Chief Executive
      OfficerDate:March
      31, 2005
   97
  
 **ANNUAL
REPORT ON FORM 20-F**
 **for
the year ended**
 **December 31,
2004**
  **EXHIBIT
INDEX**
  **ExhibitNo.
      Item**
    **Description
      of Exhibit**1.1**
    Certificate
      of Incorporation, together with all amendments. (Previously filed as
      Exhibit 1.1)1.2**
    Bylaws.
      (Previously filed as Exhibit 1.2)4.1+
    Employment
      Agreement dated December 31, 1999, between Zi Corporation and Michael
      Lobsinger. (Previously filed as Exhibit 3.4)4.2
    Amending
      Agreement, dated March 2004 between Zi corporation and Michael
      Lobsinger.4.3
    Employment
      Agreement dated, between Zi Corporation and Mike Donnell.4.4+
    Employment
      Agreement dated February 5, 2001 between Zi Corporation of America,
      Inc. and Roland Williams. (Previously filed as
      Exhibit 3.6)4.5
    Employment
      Agreement between Zi Corporation and Milos Djokovic.4.6
    Employment
      Agreement between Zi Corporation and Dale Kearns, as amended.4.7
    Employment
      Agreement between Zi Corporation and Glen Morgan.4.8**
    Zi
      Corporation Amended 1999 Stock Option Plan approved by shareholders at the
      Annual General Meeting on June 5, 2002. (Previously filed as
      Exhibit 4.13)4.9
    Zi
      Corporation 1996, 1998 and 1999 Stock Option Plans as amended (previously
      filed on Form S-8)4.10++
    Settlement
      Agreement made December 6, 2002 between America Online, Inc., Zi
      Corporation and Zi Corporation of America, Inc. (Portions of this exhibit
      have been redacted, omitted and filed separately with the Securities and
      Exchange Commission pursuant to a request for confidential treatment)
      (Previously filed as Exhibit 4.17.)4.11++
    Consent
      Judgment Order and Permanent Injunction dated December 20, 2002 made
      by The Honourable Maxine M. Chesney, United States District Court
      Judge in the United States District Court for the Northern District of
      California San Francisco Division. (Previously filed as Exhibit
      4.18.)
   
   **ExhibitNo.
      Item**
    **Description
      of Exhibit**
 8.1
    List
      of Subsidiaries (included in Item 4)11.1
    Zi
      Corporation Code of Ethics12.1
    Section 302
      Certification by Dale Kearns, Chief Financial Officer dated March 31,
      2005.12.2
    Section 302
      Certification by Mike Donnell, Chief Executive Officer dated March 31,
      2005.13.1
    Section
      906 Certification by Dale Kearns, Chief Financial Officer dated March 31,
      2005.13.2
    Section
      906 Certification by Mike Donnell, Chief Executive Officer, dated March
      31, 2005.99.1
    Audit
      Committee Charter99.2
    Consent
      of Independent Registered Chartered
Accountants
 
 *
    Previously
      filed on Form 20-F Annual Report for December 31,
      1999.+
    Previously
      filed on Form 20-F Annual Report for December 31,
      2000.**
    Previously
      filed on Form 20-F Annual Report for December 31,
      2001.++
    Previously
      filed on Form 20-F for December 31, 2003.








Management’s
Report




The
consolidated financial statements and all information in the Annual Report have
been prepared by management and approved by the Board of Directors. These
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and,
where appropriate, reflect management’s best estimates and judgements.
Management is responsible for the accuracy, integrity and objectivity of these
consolidated financial statements within reasonable limits of materiality and
for the consistency of financial data included in the text of the Annual Report
with that in these consolidated financial statements.




To assist
management in the discharge of these responsibilities, the Company maintains a
system of internal controls over financial reporting designed to provide
reasonable assurance that accounting records are reliable and assets are
safeguarded.




The Board
of Directors appoints the Audit Committee. The Audit Committee meets with
management as well as with the external auditors to satisfy itself that
management is properly discharging its financial reporting responsibilities and
to review these consolidated financial statements and the report of independent
registered chartered accountants. The Audit Committee reports its findings to
the Board of Directors for consideration in approving these consolidated
financial statements for presentation to the shareholders. The independent
registered chartered accountants have direct access to the Audit Committee of
the Board of Directors.




Deloitte
& Touche LLP has audited these consolidated financial statements
independently on behalf of the shareholders, in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Their report
outlines the nature of their audit and expresses their opinion on these
consolidated financial statements.


(signed)
    (signed)Mike
      Donnell
    Dale
      KearnsPresident
      & Chief Executive Officer
    Chief
      Financial OfficerMarch
      11, 2005
   
 F-1
 
 
 Report of
Independent Registered Chartered Accountants
  To the
Shareholders of Zi Corporation
  We have
audited the consolidated balance sheets of Zi Corporation as at December 31,
2004 and 2003 and the consolidated statements of loss, shareholders’ equity and
cash flows for each of the years in the three year period ended December 31,
2004. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
  We
conducted our audits in accordance with Canadian generally accepted auditing
standards and the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform an audit to
obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
  In our
opinion, these consolidated financial statements present fairly, in all material
respects, the financial position of Zi Corporation as at December 31, 2004 and
2003 and the results of its operations and its cash flows for each of the years
in the three year period ended December 31, 2004 in accordance with accounting
principles generally accepted in the United States of America.
  The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion.
  (signed)
"Deloitte & Touche LLP"
  Independent
Registered Chartered Accountants
 Calgary,
Alberta, Canada
 March 11,
2005
 
  Comments
By Independent Registered Chartered Accountant on Canada-United States of
America Reporting Differences
  The
standards of the Public Company Accounting Oversight Board (United States)
require the addition of an explanatory paragraph (following the opinion
paragraph) when there has been a restatement of the financial statements as
described in notes 2 and 16 to the consolidated financial statements. Our report
dated March 2, 2005, is expressed in accordance with Canadian reporting
standards, which do not require a reference to such conditions and events in the
report of independent registered chartered accountant when these are adequately
disclosed in the financial statements.
  The
standards of the Public Company Accounting Oversight Board (United States) also
require the addition of an explanatory paragraph (following the opinion
paragraph) when there are changes in accounting principles that have a material
effect on the comparability of the Company’s financial statements, such as the
change described in note 2, to the consolidated financial statements. Our report
is expressed in accordance with Canadian reporting standards which do not
require a reference to such changes in accounting principles in the report of
independent registered chartered accountant when the change is properly
accounted for and adequately disclosed in the financial statements.
  (signed)
"Deloitte & Touche LLP"
  Independent
Registered Chartered Accountants
 Calgary,
Alberta, Canada
 March 11,
2005
 
 
 F-2
 
 
 **Consolidated
      Balance Sheets**As
      at December 31
    
    2004
    
    2003(All
      amounts in United States of America dollars except share
      amounts)AssetsCurrent
      assetsCash
      and cash equivalents
    
    $
    12,889,335
    
    $
    2,366,885Accounts
      receivable, net of allowance of $154,108 (2003 - $507,640)
    
    
    5,570,869
    
    
    4,020,264Accounts
      receivable from related party(note 13)
    
    
    43,629
    
    
    33,187Prepayments
      and deposits
    
    
    414,994
    
    
    399,767Total
      current assets
    
    
    18,918,827
    
    
    6,820,103Notes
      receivable(note
      3)
    
    
    —
    
    
    2,000,000Capital
      assets - net(note 5)
    
    
    1,087,957
    
    
    1,277,755Intangible
      assets - net(note 6)
    
    
    1,692,087
    
    
    587,720Investment
      in significantly influenced company(notes
      3 and 10)
    
    
    —
    
    
    —$
    21,698,871
    
    $
    10,685,578Liabilities
      and shareholders’ equityCurrent
      liabilitiesAccounts
      payable and accrued liabilities (note 17)
    
    $
    3,081,280
    
    $
    4,099,307Deferred
      revenue
    
    
    2,704,105
    
    
    1,099,573Notes
      payable (note 7)
    
    
    —
    
    
    1,000,000Current
      portion of other long-term liabilities (note 8)
    
    
    71,969
    
    
    73,572Total
      current liabilities
    
    
    5,857,354
    
    
    6,272,452Other
      long-term liabilities(note 8)
    
    
    92,361
    
    
    132,0335,949,715
    
    
    6,404,485Contingent
      liabilities, commitments and guarantees(notes 12 & 14)Shareholders’
      equityShare
      capital(note 9)Unlimited
      number of Class A, 9% convertible, preferred shares authorizedand
      no shares issued or outstanding
    
    
    —
    
    
    —Unlimited
      number of common shares, no par value, authorized,45,225,190
      (2003 - 39,371,560) issued and outstanding
    
    
    106,025,634
    
    
    93,957,652Additional
      paid-in capital
    
    
    2,114,190
    
    
    601,744Accumulated
      deficit
    
    
    (91,927,031
    )
    
    (89,538,832
    )Accumulated
      other comprehensive loss
    
    
    (463,637
    )
    
    (739,471
    )15,749,156
    
    
    4,281,093$
    21,698,871
    
    $
    10,685,578See accompanying
      notes to consolidated financial statements.
  (signed)
    (signed)Michael
      E. Lobsinger
    Donald
      HydeChairman
      of the Board
    Director
 
 
 F-3
 
 **Consolidated
Statements of Loss**
  Years
      ended December 31
    
    2004
    
    2003
    
    2002(All
      amounts in United States of America dollars except share
      amounts)RevenueLicense
      and implementation fees
    
    $
    12,898,838
    
    $
    9,918,998
    
    $
    6,480,938Other
      product revenue
    
    
    504,213
    
    
    684,070
    
    
    1,935,30913,403,051
    
    
    10,603,068
    
    
    8,416,247Cost
      of salesLicense
      and implementation fees
    
    
    362,562
    
    
    349,824
    
    
    251,613Other
      product costs
    
    
    109,252
    
    
    85,711
    
    
    803,424471,814
    
    
    435,535
    
    
    1,055,037Gross
      margin
    
    
    12,931,237
    
    
    10,167,533
    
    
    7,361,210Operating
      expensesSelling
      general and administrative
    
    
    (9,281,365
    )
    
    (8,137,551
    )
    
    (11,371,764
    )Litigation
      and legal(note
      12)
    
    
    (833,197
    )
    
    (886,860
    )
    
    (7,511,908
    )Product
      research and development
    
    
    (2,350,141
    )
    
    (2,098,735
    )
    
    (2,780,180
    )Depreciation
      and amortization(note
      6)
    
    
    (926,886
    )
    
    (1,380,265
    )
    
    (2,226,572
    )Impairment
      of note receivable(note
      3)
    
    
    (2,000,000
    )
    
    —
    
    
    —Impairment
      of goodwill(note
      6)
    
    
    —
    
    
    —
    
    
    (1,258,889
    )Impairment
      of intangible assets(note
      6)
    
    
    —
    
    
    —
    
    
    (1,457,405
    )Operating
      loss before undernoted
    
    
    (2,460,352
    )
    
    (2,335,878
    )
    
    (19,245,508
    )Interest
      on capital lease obligation
    
    
    (25,558
    )
    
    (9,856
    )
    
    (88,614
    )Other
      interest expense
    
    
    (30,839
    )
    
    (608,858
    )
    
    (125,976
    )Interest
      income and other income
    
    
    128,550
    
    
    23,483
    
    
    182,360Equity
      interest in loss of significantly influenced company (note
    10)
    
    
    —
    
    
    —
    
    
    (220,687
    )Loss
      from continuing operations before income taxes
    
    
    (2,388,199
    )
    
    (2,931,109
    )
    
    (19,498,425
    )Income
      taxes
    
    
    —
    
    
    —
    
    
    —Loss
      from continuing operations
    
    
    (2,388,199
    )
    
    (2,931,109
    )
    
    (19,498,425
    )Discontinued
      operations(note 4)Loss
      from discontinued operations
    
    
    —
    
    
    —
    
    
    (5,707,850
    )Net
      loss
    
    $
    (2,388,199
    )
    $
    (2,931,109
    )
    $
    (25,206,275
    )Basic
      and diluted loss from continuing operations per share(note
      9)
    
    $
    (0.06
    )
    $
    (0.08
    )
    $
    (0.52
    )Loss
      from discontinued operations per share
    
    
    —
    
    
    —
    
    
    (0.15
    )Basic
      and diluted loss per share(note
      9)
    
    $
    (0.06
    )
    $
    (0.08
    )
    $
    (0.67
    )Weighted
      average common shares
    
    
    41,373,309
    
    
    38,719,786
    
    
    37,767,000Common
      shares outstanding, end of period
    
    
    45,225,190
    
    
    39,371,560
    
    
    37,914,250
 See
accompanying notes to consolidated financial statements.
   F-4
 
 **Consolidated
Statements of Shareholders’ Equity**
  Common
      shares issued
    
    
    
    
    
    AccumulatedShares
    
    Amount
    
    Additionalpaid-in
      capital
    
    Accumulateddeficit
    
    othercomprehensiveincome
      (loss)
    
    Totalcomprehensiveloss(All
      amounts in United States of America dollars except share
      amounts)Balance
      - December 31, 2001
    
    
    37,544,650
    
    $
    89,930,636
    
    $
    34,873
    
    $
    (61,401,448
    )
    $
    (1,060,565
    )Issued
      on exercise of stock options
    
    
    304,600
    
    
    720,904
    
    
    —
    
    
    —
    
    
    —Issued
      pursuant to acquisition ofMagic
      Lantern less shares held in escrow
    
    
    65,000
    
    
    324,057
    
    
    —
    
    
    —
    
    
    —Issued
      stock purchase warrants with debt
    
    
    —
    
    
    —
    
    
    154,065
    
    
    —
    
    
    —Loss
      from continuing operations
    
    
    —
    
    
    —
    
    
    —
    
    
    (19,498,425
    )
    
    —
    
    $
    (19,498,425
    )Loss
      from discontinued operations
    
    
    —
    
    
    —
    
    
    —
    
    
    (5,707,850
    )
    
    —
    
    
    (5,707,850
    )Other
      comprehensive income fromforeign
      currency translation adjustment
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    158,641
    
    
    158,641Balance
      - December 31, 2002
    
    
    37,914,250
    
    $
    90,975,597
    
    $
    188,938
    
    $
    (86,607,723
    )
    $
    (901,924
    )
    $
    (25,047,634
    )Issued
      on exercise of stock options
    
    
    301,666
    
    
    697,457
    
    
    —
    
    
    —
    
    
    —Issued
      under private placement
    
    
    1,000,000
    
    
    1,968,610
    
    
    —
    
    
    —
    
    
    —Issued
      restricted stock units
    
    
    —
    
    
    —
    
    
    516,354
    
    
    —
    
    
    —Settlement
      of debt with attachedstock
      purchase warrants
    
    
    —
    
    
    —
    
    
    (154,065
    )
    
    —
    
    
    —Exercise
      of restricted stock units
    
    
    33,961
    
    
    —
    
    
    —
    
    
    —
    
    
    —Issued
      shares on settlement of debt
    
    
    21,683
    
    
    44,827
    
    
    —
    
    
    —
    
    
    —Issued
      share purchase warrants
    
    
    —
    
    
    —
    
    
    50,517
    
    
    —
    
    
    —Issued
      on exercise of sharepurchase
      warrants
    
    
    100,000
    
    
    271,161
    
    
    —
    
    
    —
    
    
    —Loss
      from continuing operations
    
    
    —
    
    
    —
    
    
    —
    
    
    (2,931,109
    )
    
    —
    
    $
    (2,931,109
    )Other
      comprehensive income fromforeign
      currency translation adjustment
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    162,453
    
    
    162,453Balance
      - December 31, 2003
    
    
    39,371,560
    
    $
    93,957,652
    
    $
    601,744
    
    $
    (89,538,832
    )
    $
    (739,471
    )
    $
    (2,768,656
    )Issued
      on exercise of stock options
    
    
    1,143,766
    
    
    2,289,957
    
    
    —
    
    
    —
    
    
    —Issued
      under a private placement
    
    
    3,636,364
    
    
    7,067,885
    
    
    —
    
    
    —
    
    
    —Issued
      restricted stock units
    
    
    —
    
    
    —
    
    
    685,767
    
    
    —
    
    
    —Issued
      share purchase warrants toconsultant
      re private placement
    
    
    —
    
    
    (141,048
    )
    
    141,048
    
    
    —
    
    
    —Issued
      on exercise of sharepurchase
      warrants
    
    
    1,073,500
    
    
    2,851,188
    
    
    —
    
    
    —
    
    
    —Issued
      stock options to non-employee
    
    
    —
    
    
    —
    
    
    685,631
    
    
    —
    
    
    —Loss
      from continuing operations
    
    
    —
    
    
    —
    
    
    —
    
    
    (2,388,199
    )
    
    —
    
    $
    (2,388,199
    )Other
      comprehensive income fromforeign
      currency translation adjustment
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    275,834
    
    
    275,834Balance
      - December 31, 2004
    
    
    45,225,190
    
    $
    106,025,634
    
    $
    2,114,190
    
    $
    (91,927,031
    )
    $
    (463,637
    )
    $
    (2,112,365
    )
 See
accompanying notes to consolidated financial statements.
   F-5
 
 **Consolidated
Statements of Cash Flow**
  Years
      ended December 31
    
    2004
    
    2003
    
    2002(All
      amounts in United States of America dollars)Net
      cash flow from (used in) operating activities:Net
      loss from continuing operations
    
    $
    (2,388,199
    )
    $
    (2,931,109
    )
    $
    (19,498,425
    )Items
      not affecting cash:Loss
      on dispositions of capital assets
    
    
    9,899
    
    
    2,415
    
    
    146,418Depreciation
      and amortization
    
    
    926,886
    
    
    1,380,265
    
    
    2,226,572Impairment
      of note receivable
    
    
    2,000,000
    
    
    —
    
    
    —Impairment
      of goodwill
    
    
    —
    
    
    —
    
    
    1,258,889Impairment
      of intangible assets
    
    
    —
    
    
    —
    
    
    1,457,405Non-cash
      interest expense
    
    
    —
    
    
    95,344
    
    
    —Non-cash
      compensation expense
    
    
    685,767
    
    
    516,353
    
    
    —Non-cash
      consultant compensation expense
    
    
    685,631
    
    
    —
    
    
    —Equity
      in net loss of significantly influenced company
    
    
    —
    
    
    —
    
    
    220,687Decrease
      (increase) in non-cash working capital (note 17)
    
    
    (989,769
    )
    
    (370,608
    )
    
    1,202,139Cash
      flow from (used in) operating activities
    
    
    930,215
    
    
    (1,307,340
    )
    
    (12,986,315
    )Cash
      flow from (used in) financing activities:Proceeds
      from issuance of common shares, net of issuance costs
    
    
    12,209,030
    
    
    2,937,228
    
    
    720,904Settlement
      of note payable
    
    
    (1,000,000
    )
    
    (3,300,000
    )
    
    —Issuance
      of note payable
    
    
    —
    
    
    1,000,000
    
    
    3,250,450Payment
      of capital lease obligations
    
    
    —
    
    
    (96,223
    )
    
    (104,900
    )Cash
      flow from financing activities
    
    
    11,209,030
    
    
    541,005
    
    
    3,866,454Cash
      flow from (used in) investing activities:Short-term
      investments
    
    
    —
    
    
    —
    
    
    5,385,172Purchase
      of capital assets
    
    
    (178,258
    )
    
    (133,297
    )
    
    (922,171
    )Proceeds
      from capital dispositions
    
    
    —
    
    
    2,772
    
    
    32,305Software
      development costs
    
    
    (1,661,974
    )
    
    (237,618
    )
    
    (452,573
    )Other
      deferred costs
    
    
    (52,397
    )
    
    (47,622
    )
    
    152,339Acquisition
      of subsidiaries net of bank indebtedness
    
    
    —
    
    
    —
    
    
    (1,194,494
    )Sale
      of subsidiary net of cash given up
    
    
    —
    
    
    —
    
    
    (350,669
    )Cash
      flow from (used in) investing activities
    
    
    (1,892,629
    )
    
    (415,765
    )
    
    2,649,909Cash
      flow used by discontinued operations
    
    
    —
    
    
    —
    
    
    (2,290,319
    )Effect
      of foreign exchange rate changes on cash and cash
    equivalents
    
    
    275,834
    
    
    162,453
    
    
    158,641Net
      cash inflow (outflow)
    
    
    10,522,450
    
    
    (1,019,647
    )
    
    (8,601,630
    )Cash
      and cash equivalents, beginning of year
    
    
    2,366,885
    
    
    3,386,532
    
    
    11,988,162Cash
      and cash equivalents, end of year
    
    $
    12,889,335
    
    $
    2,366,885
    
    $
    3,386,532Non-cash
      financing activityEquipment
      acquired under capital lease
    
    $
    29,188
    
    $
    —
    
    $
    21,678Acquisition
      of subsidiary
    
    $
    —
    
    $
    —
    
    $
    324,057Components
      of cash and cash equivalentsCash
    
    $
    5,867,700
    
    $
    2,366,885
    
    $
    3,386,532Cash
      equivalents
    
    $
    7,021,635
    
    $
    —
    
    $
    —Supplemental
      cash flow informationCash
      paid for interest
    
    $
    56,397
    
    $
    523,370
    
    $
    87,576Cash
      paid for income taxes
    
    $
    —
    
    $
    —
    
    $
    —
 See
accompanying notes to consolidated financial statements.
   F-6
 
 
 Notes to
the Consolidated Financial Statements
  For the
years ended December 31, 2004, 2003 and 2002 (All
amounts expressed in United States of America dollars except share
amounts)
  1. Nature of
Operations
  Zi
Corporation (the “Company” or “Zi") is incorporated under the Business
Corporations Act of Alberta. Zi develops software designed to enhance the
usability of mobile and consumer electronic devices. Through its e-Learning
business segment which includes Oztime, English Practice and an equity interest
in Magic Lantern Group, Inc. (“MLG”), the Company is also involved in e-Learning
technology, content and customer service as well as educational content and
distribution channels to offer learning management systems, interactive online
courses and network education solutions to meet diverse client requirements.
  2. Significant
Accounting Policies
  The
accompanying consolidated financial statements are prepared by management in
conformity with accounting principles generally accepted in the United States of
America ("US GAAP"), which conforms in all material respects with Canadian
generally accepted accounting principles ("Canadian GAAP"), except as disclosed
in note 16. Prior to December 31, 2003, the primary consolidated financial
statements of the Company were prepared in accordance with Canadian GAAP with
annual reconciliation of the Company’s financial position and results of
operations to US GAAP. Management elected to report in conformity with US GAAP
as of December 31, 2003 to provide information on a more comparable basis with
Zi’s industry peers and to better assist with the understanding of the financial
statements to the majority of their users, who are primarily in the United
States of America. Effective March 31, 2004, the Company initiated reporting its
consolidated financial statements in US dollars, with comparative periods
restated to US dollars.
  As part
of the preparation of US GAAP consolidated financial statements, certain
additional disclosures, as compared to the previously issued Canadian GAAP
consolidated financial statements, were required. As part of the additional
disclosures, the Company re-established the previously reduced December 31, 1997
stated capital. The stated capital was reduced by the December 31, 1996 deficit
of $24,339,036, as allowed under Canadian GAAP but not under US GAAP. The result
has no effect on shareholders’ equity as at December 31, 2004, 2003 and 2002. In
addition, costs of start-up activities and organizational costs are expensed as
incurred under US GAAP. Previously capitalized start-up costs recorded in 1999,
related to the start-up of Beijing Oz Education Network Ltd., and the related
amortization expense recognized in subsequent years, have been excluded and
these costs were expensed in the year they were incurred.
  Other
revisions to disclosures throughout the consolidated balance sheets, statements
of loss, shareholders’ equity and cash flow and notes have been amended to
comply with US GAAP requirements, including comparative
disclosures.
  Note 16
includes explanations of material differences to Canadian GAAP, a reconciliation
of net loss under US GAAP to net loss using Canadian GAAP for all periods
presented, relevant Canadian GAAP disclosure not already reflected in these
consolidated financial statements and the consolidated statements of loss and
cash flows as previously presented under Canadian GAAP for the year ended
December 31, 2002.
  Principles
of consolidation
  These
consolidated financial statements include the accounts of Zi and its
subsidiaries. All inter-company transactions and balances have been eliminated.
All subsidiaries are controlled by the Company except MLG. This investment,
which the Company does not control but exercises significant influence over its
operating, investing and financing policies, is accounted for using the equity
method. The Company does not recognize its proportionate share of losses that
would result in a negative carrying value of its equity investment. Unrecorded
losses would be first offset against the Company’s proportionate share of income
from the equity investment upon the investee’s return to profitability. The
Company does not have ownership in any variable interest entities.
  Foreign
currency translation
  Zi
Corporation’s functional currency, on a stand-alone basis, is the United States
dollar. For the United States, Chinese and Hong Kong subsidiaries’, their
functional currencies are the US dollar, Chinese renminbi and the Hong Kong
dollar, respectively. The balance sheet accounts of the Company’s foreign
operations for which the local currency is the functional currency are
translated into US dollars at period-end exchange rates, while income, expense
and cash flows are translated at average exchange rates for the period.
Translation gains or losses related to net assets of such operations are shown
as a component of accumulated other comprehensive income in shareholders’
equity. Gains and losses resulting from foreign currency transactions, which are
transactions denominated in a currency other than the entity’s functional
currency, are included in the consolidation statements of loss.
  Use of
estimates
   F-7
  
 The
preparation of these consolidated financial statements and related disclosures
in conformity with US GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, the disclosure of
contingent  assets
and liabilities at the date of these financial statements, and revenue and
expenses during the period reported. Estimates include allowance for doubtful
accounts, valuation of the note receivable, estimated useful life of intangible
assets, deferred costs and capital assets, provisions for contingent
liabilities, measurement of stock-based compensation, valuation allowance for
future tax assets, and revenue for other product revenue using the percentage of
completion method, and reflect management’s best estimates. By their nature,
these estimates are subject to uncertainty and the effect on the financial
statements of changes in estimates in future periods could be significant.
Estimates and assumptions are reviewed periodically and the effects of revisions
are reflected in the period that they are determined to be necessary. The
allowance for doubtful accounts reflects estimates of doubtful amounts in
accounts receivable. The allowance is based on specifically identified accounts,
historical experience and other current information.
  Cash and
cash equivalents
  The
Company considers all balances with banks and highly liquid investments with
original maturities of three months or less to be cash and cash
equivalents.
  Capital
assets
  The
Company records capital assets at cost and provides for amortization over the
useful life of the asset using the declining-balance method at a rate of 30
percent for computer and office equipment. Leasehold improvements are recorded
at cost and amortized using the straight-line method over the shorter of the
estimated useful lives or the remaining term of the lease. The amortization
periods for leasehold improvements range from one to five years. Inducements
received upon entering into new leases have been deferred and are being
recognized as a reduction in rent expense over the corresponding lease term.
  In the
year of disposal, the resulting gain or loss is included in the consolidated
statements of loss and the cost of assets retired or otherwise disposed and the
related accumulated amortization are eliminated from these
accounts.
  Intangible
assets
  All
research and development costs are expensed as incurred except those that
qualify under Statement of Financial Accounting Standards ("SFAS") No. 86,
“Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed". Research and development costs incurred prior to the establishment of
the technological feasibility of a particular software project are expensed as
incurred. Software development costs, including costs associated with coding and
testing of project related software, are capitalized subsequent to when the
technological feasibility of a project is established. Capitalized costs are
amortized commencing in the period of the products’ commercial release. The
determination of whether a project is technically feasible involves
establishing, at a minimum, that the Company has a detailed, documented and
consistent product and program design, including high risk development issues
related to the project, with the necessary resources to complete the project. If
a detailed program design is not used, technological feasibility will be
established when a product design or working model of the software model,
consistent with the product design, is complete and tested.
  Costs of
start-up activities and organizational costs are expensed as incurred. Start-up
costs include those one-time activities related to organizing a new
entity.
  The
Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets” in 2002. The
Company records intangible assets, excluding goodwill and intangible assets with
indefinite lives at cost and provides for amortization over their expected
useful lives using the straight-line method over the following
periods:
  Acquired
      software licenses
    3
      yearsPatents
      acquired
    11
      yearsSoftware
      development costs
    3
      years
  Goodwill
and other intangible assets with indefinite lives are not amortized, but are
tested for impairment at least annually, or more frequently, if events or
changes in circumstances indicate that the asset might be impaired in accordance
with SFAS No. 142. The Company evaluated its goodwill and intangible assets for
impairment at September 30, 2002 and determined that an impairment charge was
necessary (note 6).
  Impairment
of long-lived assets
  In August
2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 144.
SFAS No. 144 established a single model for the impairment of long-lived assets
and broadens the presentation of discontinued operations to include a component
of the entity. SFAS No. 144 is effective for years beginning after December 15,
2001.The Company adopted SFAS No. 144 in 2002. The Company annually reviews the
carrying value of it’s long-lived assets, including intangible assets, on
September 30 of each year and periodically reviews the carrying value of its
intangible assets whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. To the extent the estimated future net
cash inflows from such assets is less than the carrying amount, an impairment
loss is recognized. The Company considers factors such as significant changes in
the business climate and projected discounted cash flows from the respective
assets. The Company evaluated its remaining intangible assets at September 30,
2004 and determined that no impairment had occurred.
   F-8
 
 Revenue
recognition
  Revenues
from software licensing royalties related to the sale of the product in which
the Company’s technologies have been embedded are recorded as earned. Software
licensing royalties are included in fees from licensing and
implementation.
  Under
software licensing arrangements, the Company recognizes revenues - provided
that: a non-cancellable license agreement has been signed; the software and
related documentation have been delivered; there are no uncertainties regarding
customer acceptance; collection of the resulting receivable is deemed probable;
the fees are fixed and determinable; and no other significant vendor obligations
exist. Any revenue associated with contracts having multiple elements is
deferred and recognized ratably over the period of the contract unless clear
evidence exists with respect to the fair value of each separate element of the
contract. Fair value for each separate element is evidenced by existing customer
contract which stipulate rates associated with separate yet similar services or
deliverables. In addition, contracts involving significant modifications or
customization of the software sold are accounted for under the guidelines of
contract accounting.
  Customer
support revenues consist of revenue derived from contracts to provide post
contract support, such as maintenance and service support, to license holders.
These revenues are recognized ratably over the term of the
contract.
  Revenue
from Oztime product contracts recorded in other product revenue is recognized
using the percentage of completion method, whereby revenue is recorded at the
estimated realizable value of work completed to date and costs incurred to date
are compared to total estimated contract costs to determine whether a loss will
be realized. Amounts received in advance are recorded as deferred revenue.
Estimated losses on contracts are recognized when they become known. Other
product revenue recorded by the Company is mainly comprised of revenue for the
e-Learning business segment and this revenue is recognized through the
percentage of completion method as previously described.
  Income
taxes
  The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes", wherein the liability method is used for determining income
taxes. Under this method, deferred income tax assets and liabilities are
recognized for the estimated tax recoverable or payable that would arise if
assets and liabilities were recovered and settled at the financial statement
carrying amounts. Future tax assets and liabilities are measured using enacted
tax rates and laws expected to apply to taxable income in the years in which
temporary differences are expected to be recovered or settled. Valuation
allowances are provided when necessary to reduce net future tax assets to an
amount that is more likely than not to be realized.
  Leases
  Leases
are classified as capital or operating leases. A lease that transfers to the
lessee substantially all the benefits and risks incidental to ownership is
classified as a capital lease. At inception, a capital lease is recorded as if
it were an acquisition of an asset and the incurrence of an obligation. Assets
recorded as capital leases are amortized on a basis consistent with that of
accounting for capital assets. Operating lease costs are expensed as
incurred.
  Share
issue costs
  The
Company reduced the value of consideration assigned to shares issued by direct
costs, net of applicable income tax recoveries, of issuing the
shares.
  Loss per
share
  Loss per
share is computed based on the weighted average basic number of shares
outstanding for the period. Diluted loss per share has been calculated using the
treasury stock method, whereby diluted loss per share is calculated as if
options, restricted stock units ("RSU’s") and common share purchase warrants
were exercised at the beginning of the year and funds received were used to
purchase the Company’s own stock. Diluted shares have not been used in
calculating diluted loss per share for the years ended December 31, 2004, 2003
and 2002 as they were anti-dilutive. Common shares held in escrow that are
subject to future performance level criteria are excluded in the calculation of
loss per share (nil in 2004, 35,000 in 2003, 75,000 in 2002).
  Comprehensive
loss
  SFAS No.
130, “Reporting Comprehensive Income", establishes standards for the reporting
and display of comprehensive income and its components in general-purpose
financial statements. Comprehensive income is defined as the change in net
assets of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources, and includes all changes in
equity during a period except those resulting from investment by owners and
distributions to owners. Comprehensive income (loss) includes foreign currency
translation adjustments. The Company has reported components of comprehensive
income (loss) on its consolidated statement of shareholders’
equity.
  Financial
instruments
   F-9
  Accounts
receivable, cash equivalents, investment in significantly influenced company,
accounts payable, accrued liabilities, note payable, capital lease obligations
and other deferred costs constitute financial instruments. The carrying values
of these financial instruments approximate their fair value given the relatively
short periods to maturity, except for the note receivable and the investment in
significantly influenced company. The carrying values for these financial
instruments represent their maximum credit risk. The note receivable constitutes
a financial instrument with a fair value that is not determinable due, in part,
to the unrecognized contingent portion of the note (note 3). The investment in
significantly influenced company constitutes a financial instrument with a fair
value that is not determinable due to the unavailability of independent third
party evidence to support a valuation of this investment.
  The
Company maintains substantially all cash and cash equivalents with major
financial institutions. Deposits held with banks may exceed the amounts of
insurance provided on such deposits. Credit risk exposure includes accounts
receivable with customers primarily located in North America, China, Korea, and
Western Europe. The Company performs ongoing credit evaluations of its
customers’ financial condition and, generally, requires no collateral from
customers. The Company is exposed to the risks arising from fluctuations in
foreign exchange rates, and the volatility of those rates. The Company does not
use derivative instruments to reduce its exposure to foreign currency exchange
risk.
  Stock-based
compensation plan
  As
permitted under SFAS No. 123, “Accounting for Stock-Based Compensation", in
accounting for the grant of the Company’s employee and director stock options,
the Company has elected to use the intrinsic value method, following Accounting
Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”
("APB No. 25"), and related interpretations. Under APB No. 25, companies are not
required to record any compensation expense relating to the grant of options to
employees or directors where the awards are granted upon fixed terms with an
exercise price equal to fair value at the date of grant and the only condition
of exercise is continued employment. The Company accounts for RSU’s in
accordance with SFAS No. 123, whereby the intrinsic value method is used and the
related compensation expense is recognized over the vesting period.
  The
Company has a stock-based compensation plan, which is described in note 9. Any
consideration paid by employees on exercise of stock options or purchase of
stock is credited to share capital. If stock or stock options are repurchased
from employees, the excess of the consideration paid over the carrying amount of
the stock or stock option cancelled is charged to retained
earnings.
  Under
SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-based
Compensation - Transition and Disclosure, an Amendment of FASB Statement No.
123", companies that elect a method other than the fair value method of
accounting are required to disclose pro forma net loss and loss per share
information, using an option pricing model such as the Black-Scholes model, as
if the fair value method of accounting had been used. Had compensation cost for
the Company’s employee stock option plan been determined by this method, Zi’s
net loss and loss per share would have been as follows:
  2004
    
    2003
    
    2002Net
      loss from continuing operations:
    
    
    
    Restated
      (1)As
      reported
    
    $
    (2,388,199
    )
    $
    (2,931,109
    )
    $
    (19,498,425
    )Stock
      compensation expense
    
    
    (3,901,903
    )
    
    (4,317,459
    )
    
    (6,076,291
    )Pro
      forma
    
    
    (6,290,102
    )
    
    (7,248,568
    )
    
    (25,574,716
    )Loss
      from discontinued operations:
    
    
    —
    
    
    —
    
    
    (5,707,850
    )Pro
      forma net loss:
    
    $
    (6,290,102
    )
    $
    (7,248,568
    )
    $
    (31,282,566
    )Net
      loss per common share from continuing operations:As
      reported, basic and diluted
    
    $
    (0.06
    )
    $
    (0.08
    )
    $
    (0.52
    )Stock
      compensation expense, basic and diluted
    
    
    (0.09
    )
    
    (0.11
    )
    
    (0.16
    )Pro
      forma, basic and diluted
    
    $
    (0.15
    )
    $
    (0.19
    )
    $
    (0.68
    )Loss
      per share from discontinued operations
    
    
    —
    
    
    —
    
    
    (0.15
    )Net
      loss per common share basic and diluted
    
    $
    (0.15
    )
    $
    (0.19
    )
    $
    (0.83
    )Stock
      options and RSU’s issued during period
    
    
    2,105,500
    
    
    2,342,532
    
    
    306,666Weighted
      average exercise price
    
    $
    2.27
    
    $
    2.50
    
    $
    5.60Weighted
      average fair value of stock options granted during the
    period
    
    $
    1.19
    
    $
    1.39
    
    $
    2.75
  (1) At
December 31, 2004, the Company’s stock based compensation expense has been
reallocated to better reflect the variety of vesting periods of its stock option
grants. In 2003, the determination of the stock based compensation expense was
based on amortization periods that did not best reflect the variety of vesting
periods for the associated stock option grants. Accordingly, the Company has
restated the 2003 stock compensation expense and appropriate related balances as
follows:
   F-10
   2003Pro
      forma net loss as previously stated
    
    $
    (6,441,613
    )Stock
      compensation expense as previously stated
    
    
    3,510,504Restatement
      of stock compensation expense
    
    
    (4,317,459
    )Restated
      pro forma net loss
    
    $
    (7,248,568
    )Pro
      forma net loss per share as previously stated, basic and
      diluted
    
    $
    (0.17
    )Restatement
      of stock compensation expense, basic and diluted
    
    
    (0.02
    )Restated
      pro forma net loss per share, basic and diluted
    
    $
    (0.19
    )
 
 2004
    
    2003
    
    2002Risk
      free interest rate
    
    
    3.60
    %
    
    3.80
    %
    
    3.94
    %Expected
      life in years
    
    
    3.7
    
    
    3.8
    
    
    3.0Expected
      dividend yield
    
    
    0
    %
    
    0
    %
    
    0
    %Expected
      volatility
    
    
    52
    %
    
    65
    %
    
    70
    %
  Recent
accounting pronouncements
  In
December 2004, FASB issued SFAS No. 123R “Share Based Payment.” This statement
is a revision to SFAS No.123 and supersedes APB Opinion No. 25, “Accounting for
Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash
Flows". This statement requires a public entity to expense the cost of employee
services received in exchange for an award of equity instruments. This statement
also provides guidance on valuing and expensing these awards, as well as
disclosure requirements of these equity arrangements. This statement is
effective for the first interim reporting period that begins after June 15,
2005. SFAS No. 123R permits public companies to choose between the following two
adoption methods:
  1.
    A “modified prospective” method in which
      compensation cost is recognized beginning with the effective date (a)
      based on the requirements of SFAS No. 123R for all share-based payments
      granted after the effective date and (b) based on the requirements of SFAS
      No. 123 for all awards granted to employees prior to the effective date of
      SFAS No. 123R that remain unvested on the effective date,
    or2.
    A “modified retrospective” method which
      includes the requirements of the modified prospective method described
      above, but also permits entities to restate based on the amounts
      previously recognized under SFAS No. 123 for purposes of pro forma
      disclosures either (a) all prior periods presented or (b) prior interim
      periods of the year of adoption.
 As
permitted by SFAS No. 123, the Company currently accounts for share-based
payments to employees using APB Opinion No. 25’s intrinsic value method and, as
such, the Company generally recognizes no compensation cost for employee stock
options. The impact of the adoption of SFAS No. 123R cannot be predicted at this
time because it will be dependent on levels of share-based payments granted in
the future. Accordingly, the adoption of SFAS No. 123R’s fair value method will
have a significant impact on the Company’s results of operations, although it
will have no impact on the Company’s overall financial position.
  The
Company has not yet completed the analysis of the ultimate impact that this new
pronouncement will have on the results of operations, nor the method of adoption
for this new standard.
  In
November 2004, the FASB issued SFAS No. 151, “Inventory Costs”, an amendment of
ARB No. 43. This statement amends Accounting Research Bulleting (“ARB”) No. 43
to clarify that abnormal amounts of idle facility expense, freight, handling
costs, and wasted materials should be recognized as current period charges. In
addition, SFAS No. 151 requires that allocation of fixed production overheads to
the costs of conversion be based on the normal capacity of production
facilities. The provisions of this statement are to be applied prospectively,
and the statement is effective for fiscal years beginning after June 15, 2005,
with earlier application permitted for inventory costs incurred in fiscal years
beginning after November 2004. Adoption of this statement is not expected to
have a material impact on the Company’s consolidated financial position, results
of operations or liquidity, as the Company does not hold inventory.
  In
December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets,
an amendment of APB Opinion No. 29.” The amendments made by SFAS No. 153 are
based on the principle that exchanges of non-monetary assets should be measured
based on the fair value of the assets exchanged. The amendment also eliminates
the narrow exception for non-monetary exchanges of similar productive assets and
replaces it with a broader exception for exchanges of non-monetary assets that
do not have commercial substance. The provisions of this statement are effective
for non-monetary asset exchanges occurring in fiscal periods beginning after
June 15, 2005. The Company does not expect the adoption of SFAS No. 153 to have
a material impact on our financial condition or our results of operations.
   F-11
  In
January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
“Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.”
FIN 46 requires certain variable interest entities (entities where the equity
investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties) to be consolidated by the primary beneficiary of the entity. The
adoption of FIN 46R did not have a material impact upon the Company’s financial
position, cash flows or results of operations.
  In March
2004, the FASB’s Emerging Issues Task Force ("EITF") reached a consensus on
Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairments and Its
Application to Certain Investments.” EITF No. 03-01 provides a three-step
impairment model for determining whether an investment is other-than-temporarily
impaired and requires the recognition of such impairments as an impairment loss
equal to the difference between the investment’s cost and fair value at the
reporting date. The guidance is effective during the first quarter of fiscal
2005. The Company does not believe that the adoption of EITF No. 03-01 will have
a significant effect on its financial position, results of operations or cash
flows.
  In
September 2004, EITF Issue 4-10 “Determining Whether to Aggregate Operating
Segments That Do Not Meet the Quantitative Thresholds"("EITF 4-10") was issued,
which addresses the criteria for aggregating operating segments. The Company
reviewed the segment reporting and determined that our aggregation of segments
is consistent with the guidance in EITF Issue No. 4-10.
  3.
    Acquisitions and
  Dispositions
 All
acquisitions have been accounted for using the purchase method with results from
operations included in these consolidated financial statements from the date of
acquisition.
  Acquisition
- Magic Lantern Communications Ltd. ("Magic Lantern")
  Effective
March 18, 2002, the Company indirectly acquired all of the issued and
outstanding shares of Magic Lantern. Magic Lantern is a Canadian education
content provider with two subsidiaries: Tutorbuddy Inc., which is wholly owned;
and Sonoptic Technologies Inc. ("STI"), which is 75 percent owned. The remaining
25 percent of STI is held by Provincial Holdings Ltd. ("PHL") and is subject to
a redemption agreement.
  Magic
Lantern was acquired for cash consideration of $1,172,667, and 100,000 common
shares of Zi with a value of $498,549 based on the Company’s closing share price
on the date of the agreement. Of the Zi common shares issued, 35,000 shares were
placed in escrow subject to future performance obligations. In addition, there
were acquisition costs amounting to $103,903 to effect the business
combination.
  At
December 31, 2002, it was determined that the performance obligations attached
to the 35,000 shares placed in escrow would most likely not be met. These
escrowed shares were originally included in the determination of the purchase
price at the purchase date. As a result, the purchase price was adjusted by
$174,492 to reflect the exclusion of the escrowed shares and the resulting
negative goodwill was allocated to the assets purchased. The purchase price was
allocated as follows:
  Net
      assets acquired:Bank
      indebtedness
    
    $
    (21,826
    )Non-cash
      working capital
    
    
    33,446Notes
      payable
    
    
    (554,832
    )Capital
      assets
    
    
    1,029,233Software
      development costs
    
    
    290,569Distribution
      agreements
    
    
    824,037$
    1,600,627
  Disposition
- Magic Lantern Communications Ltd
  On
November 7, 2002, the Company completed the sale of the Magic Lantern to JKC
Group Inc. ("JKC"), a related party (note 13) and an American Stock Exchange
listed company incorporated in the state of New York. Magic Lantern operations
comprise the most significant portion of JKC’s operations subsequent to the
sale. Following the closing of the transaction on November 7, 2002, JKC was
renamed to Magic Lantern Group, Inc. ("MLG").
  Under the
agreement, Zi received a 45 percent equity interest in MLG, consisting of
29,750,000 shares, and a three-year promissory note of MLG in the amount of
$3,000,000, at the interest rate of 5 percent per annum, due in full November 7,
2005. The note consideration was subject to adjustment based on the MLG’s
performance for the first year after the sale. The performance criteria
stipulated under the agreement were not met. The purchase price was reduced as
MLG revenues for the performance period were less than the required $5,000,000.
As a result of the shortfall, $1,000,000 was offset against the principal amount
of the MLG promissory note reducing it to $2,000,000.
 
 
 F-12
  The
Company accounted for the sale at the date of closing by recognizing its
interest in the net assets of MLG acquired and 55 percent of the promissory note
received, excluding the note’s contingent portion of $1,000,000. The Company’s
$2,220,687 book value for Magic Lantern at November 7, 2002, consisting of
patents, distribution agreements, capital and current net assets, upon closing
of the transaction resulted in a note receivable and an investment in shares, in
the amount of $2,000,000 and $220,687 respectively, with no gain recognized. A
nominal value has been ascribed to the MLG stock consideration received.
  Net
      assets disposed:Cash
    
    $
    350,669Non-cash
      working capital
    
    
    34,451Capital
      assets
    
    
    1,018,209Deferred
      development costs
    
    
    548,354Distribution
      agreements & other
    
    
    774,286Notes
      payable
    
    
    (505,282
    )$
    2,220,687
  At
December 31, 2004, the Company evaluated the note receivable for impairment and
determined that subject to SFAS no. 114 “Accounting by Creditors for Impairment
of Loan” using a projected discounted cash flow model at the loan’s effective
interest rate, the full amount of the note receivable including accrued interest
was impaired and was provided for. The Company believes in MLG’s continued
viability, but MLG is currently under a going concern qualification and subject
to its ongoing operating cash requirements, continued operating losses and other
debt, to which the Company is subordinate. Due to these factors and the absence
of private placements originally anticipated by MLG to occur in the fourth
quarter of 2004, it is probable that MLG will not have the necessary funds
available to meet the requirements under the note, including accrued interest.
Interest due on the note will not be accrued but will be recognized only upon
payment by MLG of such interest.
  4.
    Discontinued Operations
 Through
the Company’s discontinued Zi Services business segment, Zi provided specialized
product development and customized solutions in BluetoothTM, VoIP and man-machine
interface design to the telecommunications industry.
  On June
30, 2002, the Board of Directors of the Company approved the adoption of a plan
to dispose of its Zi Services business segment, the telecom engineering division
of the Company. Accordingly, the results of operations of these businesses were
accounted for on a discontinued basis as at June 30, 2002. On July 1, 2002, the
Company announced that it had signed a letter of intent to sell Zi Services. On
October 31, 2002 the letter of intent expired and the sale was not executed.
Management determined that the carrying value of Zi Services, consisting of
deferred software development costs of $1,965,345, goodwill of $477,396, capital
assets of $32,697 and net current assets of $200,558 were no longer recoverable.
As a result, the Company recognized a charge of $2,675,996 in 2002. As at
December 31, 2002, the Company sold the remaining assets of this business
segment and no longer carries on any related business activities.
  Year
      ended December 31, 2002Revenue
    
    $
    153,030Operating
      loss
    
    $
    (5,707,850
    )
  5.
    Capital
Assets
 
 Cost
    
    Accumulatedamortization
    
    Net
      bookvalue2004Computer
      and office equipment
    
    $
    3,041,544
    
    $
    2,188,900
    
    $
    852,644Leasehold
      improvements
    
    
    527,452
    
    
    292,139
    
    
    235,313$
    3,568,996
    
    $
    2,481,039
    
    $
    1,087,9572003Computer
      and office equipment
    
    $
    2,788,800
    
    $
    1,834,204
    
    $
    954,596Leasehold
      improvements
    
    
    839,049
    
    
    515,890
    
    
    323,159$
    3,627,849
    
    $
    2,350,094
    
    $
    1,277,755
   F-13
  Included
in computer and office equipment are assets under capital lease totalling
$494,130 (2003 -$428,489) and related accumulated amortization of $334,052 (2003
- $257,654).
  6.
    Intangible
Assets
 
 Cost
    
    Accumulatedamortization
    
    Net
      bookvalue2004Patent
    
    $
    547,709
    
    $
    298,155
    
    $
    249,554Software
      development costs
    
    
    8,281,828
    
    
    6,839,295
    
    
    1,442,533$
    8,829,537
    
    $
    7,137,450
    
    $
    1,692,0872003Patent
    
    $
    605,234
    
    $
    318,788
    
    $
    286,446Software
      development costs
    
    
    11,963,682
    
    
    11,662,408
    
    
    301,274Acquired
      software licenses
    
    
    58,346
    
    
    58,346
    
    
    —$
    12,627,262
    
    $
    12,039,542
    
    $
    587,720
  During
2004, $1,661,974 (2003— $237,618) of software development costs were deferred
and are being amortized using the straight-line method over a three-year
economic life. Amortization in 2004 includes $510,167 and $47,440 of
amortization of development costs and patents, respectively
 (2003 -
$861,309 and $59,822, respectively).
  In
accordance with SFAS No.142, the Company tested for impairment of goodwill at
September 30, 2002, using a projected discounted cash flow model, and recorded
an impairment charge of $1,258,889 in the year. This charge was in respect to
remaining goodwill associated with the purchase of the Chinese e-Learning
business, in light of the disposition of a significant portion of its e-Learning
business segment through the sale of Magic Lantern and limitations for funding
e-Learning businesses future development and growth.
  GoodwillNet
      book value - December 31, 2001
    
    $
    1,258,889Impairment
      - September 30, 2002
    
    
    (1,258,889
    )Net
      book value - December 31, 2002
    
    $
    —
  The
Company evaluated its other intangible assets at September 30, 2004 and
determined that no impairment had occurred. The Company had reviewed the
carrying value of its other intangible assets and determined that the deferred
software development costs related to the Company’s China based e-Learning
business at September 30, 2002, using a projected discounted cash flow model,
were not recoverable in light of limitations for funding its future development
and growth and recorded a charge of $1,457,405.
  The
following is the estimated amortization expense of intangible assets for each of
the next five years:
  2005
    
    $
    652,0962006
    
    
    619,6702007
    
    
    320,1412008
    
    
    49,7922009
    
    
    14,396Total
    
    $
    1,656,095
  7.
    Notes
Payable
 
 On
December 19, 2003, the Company borrowed $1,000,000 through the issuance of a
demand loan payable. The note payable bore interest at the prime rate (4.5
percent at December 31, 2003) plus one percent payable monthly. The facility is
secured by a first security interest in 5,000,000 shares of MLG, held by the
Company. On July 20, 2004, the Company repaid, in full, this demand note. As at
December 31, 2004, the amount drawn on the facility is nil (December 31, 2003 -
$1,000,000) and the facility remains available for the Company’s future
use.
  On
December 5, 2002, the Company borrowed $3,300,000 (before deduction for fees and
expenses) through the issuance of a note payable. The note payable, with
interest at 12 percent per annum and payable monthly, was due March 5, 2003,
extended to April 30, 2003 and subsequently to May 7, 2003, at which time it was
settled in full. The lender was issued 100,000 share purchase warrants upon
funding, which were exercisable at one common share to one share purchase
warrant for a price of CDN$3.62 per share (note 9). A commitment fee of $300,000
was paid upon funding. The first extension terms included a four percent
extension fee of $130,800 paid upon funding. The note was secured through a
general security agreement, a limited recourse guarantee by a private company
owned by an officer of the Company at the time who is also a director of the
Company and a share pledge agreement by the Company which pledged and granted a
first security interest in 29,750,000 shares of MLG, held by the
Company.
 
 
 F-14
  On May 7,
2003, the Company entered into a new secured short-term credit facility in the
amount of $1.94 million, which was settled in full June 20, 2003. The note
included interest payable at 12 percent per annum. The terms of the note payable
provided for a bonus payment of $45,000, payable in common
shares of the Company, paid 30 days from the date of the agreement as the loan
balance remained unpaid as of that date. The note was secured through a general
security agreement, a limited recourse guarantee by a private company owned by
an officer of the Company at the time who is also a director of the Company and
a share pledge agreement by the Company which pledges and granted a first
security in 29,750,000 shares of MLG, held by the Company.
  8.
    Capital Lease Obligations and Leasehold
      Improvements
 
 The
Company has entered into leases for computer and office equipment with payment
terms over three years with interest at rates varying between 10.20 percent and
17.25 percent. Obligations as at December 31, 2004 were $25,519 (2003 -
$25,435). The current portion at December 31, 2004 was $16,445 (2003 -
$22,095).
  The
future minimum lease payments under the capital leases are as
follows:
  2005
    
    $
    19,1972006
    
    
    8,0492007
    
    
    1,813Total
      minimum lease payments
    
    
    29,059Amount
      representing interest
    
    
    3,540Amount
      included in current liabilities
    
    
    16,445$
    9,074
  Inducements
for leasehold improvements received by the Company upon entering into new leases
as at December 31, 2004 were $138,811 (2003 - $180,170). The current portion at
December 31, 2004 was $55,524 (2003 - $51,477).
  9.
    Share Capital
 
 Stock
purchase warrants
  On July
16, 2004, the Company completed a private placement of 3,636,364 units priced at
CDN$2.75 per unit for net proceeds of $6,926,836. Each unit consists of one
share of the Company’s stock and one-half of a stock purchase warrant. Each
whole stock purchase warrant is exercisable into one share of the Company’s
stock on or before July 16, 2006 at an exercise price of CDN$3.25 per share. At
December 31, 2004, 844,682 of these stock purchase warrants are outstanding. As
part of the consideration for services rendered by an agent related to this
private placement, the Company has issued 218,182 stock purchase warrants with
each warrant exercisable through the purchase of one common share at a price of
CDN$3.25. The warrants are exercisable immediately and expire, if unexercised
two years from the date of issue. At December 31, 2004, 118,182 of these stock
purchase warrants are outstanding. The Company accounted for the 218,182 stock
purchase warrants in accordance with SFAS No. 123 and recognize as part of
common share issue costs $141,048, calculated by using the Black-Scholes option
pricing model to arrive at net proceeds. Under the terms of the private
placement, the units sold in the private placement are subject to statutory
restrictions on resale, including hold periods.
  At
December 31, 2003, the Company had 0.5 million share purchase warrants
outstanding. On June 19, 2003, the Company completed a private placement of 1.0
million units priced at $2 per unit for net proceeds of $1,968,610. Each unit
consists of one share of the Company’s stock and one-half of a stock purchase
warrant. Each whole stock purchase warrant is exercisable into one share of the
Company’s stock on or before May 31, 2006 at an exercise price of $2.25 per
share. Under the terms of the private placement, the units sold in the private
placement are subject to statutory restrictions on resale, including hold
periods. At December 31, 2004, these 0.5 million share purchase warrants are
outstanding.
  On
December 5, 2002, the Company issued, in conjunction with a note payable of
$3,300,000, 100,000 share purchase warrants to acquire 100,000 common shares of
the Company at a price of CDN$3.62 per share, which were to expire two years
from the date of issue (note 7). In 2002, the Company allocated $154,065 which
represents the equity value of the warrants issued with the debt, calculated by
using the Black-Scholes option pricing model. In June 2003, the Company issued
100,000 shares through the exercise of these 100,000 share purchase warrants.
  Stock
options and restricted stock units
  At
December 31, 2004, the Company maintained a Stock Option Plan for all directors,
officers, employees and consultants of the Company.
 
 
 F-15
  Under the
terms of the Stock Option Plan, options and RSU’s may be granted at the
discretion of the Board of Directors. The option price equals the closing price
of the Company’s shares on the day preceding the date of grant. The options and
RSU’s are not assignable, vest at the discretion of the Board of Directors, and
expire, at maximum, after the tenth anniversary of the date of grant. In 2004,
250,000 (2003 - 162,532) RSU’s were granted and issued without performance
criteria attached and at no cost to the grantee. At December 31, 2004, 378,571
(2003 - 128,571) RSU’s are outstanding. The RSU’s vest upon granting and expire
five years from the date of grant. The Company has recorded, as part of selling,
general and administration expense, compensation expense of $685,767 (2003 -
$516,353) related to the RSU’s calculated by using the intrinsic value
method.
  The
Company entered into a Financial Advisory Services Agreement effective January
9, 2004 with an unrelated third party. The agreement stipulates that the third
party shall provide to the Company management and consulting services for a
period of one year from the date of the agreement. As consideration for these
services, the Company has granted 400,000 stock options with each option
exercisable through the purchase of one common share at a price of CDN$3.25. The
options vest immediately and expire, if unexercised five years from the date of
grant. The Company has accounted for these options in accordance with SFAS No.
123 and has recognized $685,631 in 2004 as part of selling, general and
administrative expense calculated by using the Black-Scholes option pricing
model.
  Since
inception of the Stock Option Plan in 1993, shareholders have approved
resolutions reserving a total of 11,615,000 common shares for issuance under the
plan of which 500,000 are issuable as RSU’s. At December 31, 2004, the Company
had 830,652 common shares (87,468 of which are reserved for RSU’s) remaining
reserved for possible future allocation under the plan.
  Stock
option and RSU activity and related information for the three years ended
December 31, 2004 is as follows:
  2004
    
    2003
    
    2002Sharesunder
      optionsand RSU’s
    
    Weightedaverageexercise
      price
    
    Sharesunder
      optionsand RSU’s
    
    Weightedaverageexercise
      price
    
    Sharesunder
      options
    
    Weightedaverageexercise
      priceOutstanding,beginning
      of year
    
    
    5,474,904
    
    $
    5.18
    
    
    5,135,700
    
    $
    5.65
    
    
    5,874,852
    
    $
    5.92Granted
    
    
    2,105,500
    
    
    2.27
    
    
    2,342,532
    
    
    2.50
    
    
    306,666
    
    
    5.60Exercised
    
    
    (1,143,766
    )
    
    (2.00
    )
    
    (335,627
    )
    
    (2.08
    )
    
    (304,600
    )
    
    (2.37
    )Forfeited
      or expired
    
    
    (1,524,666
    )
    
    (7.78
    )
    
    (1,667,701
    )
    
    (3.48
    )
    
    (741,218
    )
    
    (9.10
    )Outstanding,
      end of year
    
    
    4,911,972
    
    $
    4.28
    
    
    5,474,904
    
    $
    5.18
    
    
    5,135,700
    
    $
    5.65Exercisable,
      end of year
    
    
    4,102,142
    
    $
    4.54
    
    
    4,683,732
    
    $
    5.55
    
    
    4,671,129
    
    $
    5.54Weighted-average
      fair value of stock options and RSU’s granted during the
    year
    $
    1.19
    
    
    
    
    $
    1.39
    
    
    
    
    $
    2.75
 
  The
following table summarizes the exercise price ranges of outstanding and
exercisable stock options as of December 31, 2004:
 Total
      stock options and RSU’s outstanding
    
    Stock
      options and RSU’s exercisableRange
      of exercise prices
    
    Number
      outstandingDecember 31,  2004
    
    Weightedaverage
      remainingcontractual life
    
    
    Weighted
      averageexercise price
    
    Number
      exercisable
      December
      31, 2004
    
    
    Weighed
      average
      exercise
      price$
      1.75–
    
    $4.16
    
    3,643,972
    
    3.7
      years
    
    $
    2.54
    
    2,845,642
    
    $
    2.46$
      4.33–
    
    $8.91
    
    513,000
    
    1.3
      years
    
    
    7.80
    
    511,500
    
    
    7.81$
      9.70 –
    
    $12.52
    
    755,000
    
    1.3
      years
    
    
    10.28
    
    745,000
    
    
    10.25$
      1.75 –
    
    $12.52
    
    4,911,972
    
    3.1
      years
    
    $
    4.28
    
    4,102,142
    
    $
    4.54
  Escrowed
shares
  Pursuant
to the acquisition of English Practice Inc. ("EPI") on June 15, 2000 and to the
terms of an amended purchase agreement, the Company had placed in
escrow 40,000 common shares subject to release based upon performance
obligations. The performance obligations were not met under the terms of the
amended purchase agreement and were subsequently cancelled in 2003. Pursuant to
the acquisition of Magic Lantern (note 3), the Company had placed in escrow
35,000 common shares that were subject to release based upon performance
obligations. The performance obligations were not met under the terms of the
purchase agreement and the escrowed shares were cancelled in 2004.
   F-16
   10.
    Equity Interest in Significantly Influenced
      Company
 
 The
Company holds a 43.6 percent (as calculated from MLG’s Form 10-Q dated November
10, 2004) interest in MLG, a related party, received upon the disposition of the
Magic Lantern on November 7, 2002 (note 3). The Company’s proportionate share of
the loss from MLG operations for the year ended December 31, 2004 has not been
recognized as the carrying value of the investment in MLG is nil and the Company
has no commitment to fund this loss. The Company’s unrecorded share of the loss
from MLG’s operations between November 8, 2002 and September 30, 2004 is the sum
of $2,863,000 and will be used to offset the Company’s proportionate share of
MLG’s future income upon MLG’s return to profitability. At December 31, 2004,
the Company held 29,750,000 shares of MLG which, at that date’s closing price of
$0.45 per share, results in a market value of $13,387,500 for this investment.
This market value may not be representative of the fair value of this
investment.
  11.
    Income Taxes
 
 Substantially
all of the Company’s activities are carried out through operating subsidiaries
in several countries. The income tax effect of operations depends on the tax
legislation in each country and operating results of each subsidiary and the
parent company. The provision for income taxes reflects an effective tax rate
that differs from the corporate tax rate for the following reasons:
  2004
    
    2003
    
    2002Combined
      basic federal, provincial and state income tax rate
    
    36.6%
    
    39%
    
    39%Expected
      combined Canadian federal and provincial tax recovery based on above
      rates
    
    $
    (874,081
    )
    $
    (1,392,979
    )
    $
    9,984,134
    )Enacted
      tax rate adjustment differences
    
    
    151,862
    
    
    172,549
    
    
    670,307Differences
      in foreign statutory tax rates
    
    
    149,344
    
    
    (324,918
    )
    
    2,069,983Permanent
      differences
    
    
    618,992
    
    
    338,079
    
    
    48,661Loss
      on dissolution of subsidiaries
    
    
    1,159,877
    
    
    —
    
    
    —Impairment
      of note receivable
    
    
    677,400
    
    
    —
    
    
    —Loss
      on sale of Zi Services assets
    
    
    —
    
    
    —
    
    
    (871,903
    )Gain
      on sale of Magic Lantern
    
    
    —
    
    
    —
    
    
    4,566,545Equity
      loss in significantly influenced company
    
    
    —
    
    
    —
    
    
    85,154Unrecognized
      recoveries on losses
    
    
    (2,619,798
    )
    
    (1,263,234
    )
    
    (2,389,187
    )Non-deductible
      goodwill
    
    
    —
    
    
    —
    
    
    770,382Other
    
    
    (15,350
    )
    
    (195,908
    )
    
    (30,724
    )Valuation
      allowance
    
    
    751,754
    
    
    2,666,411
    
    
    5,064,916Consolidated
      income tax
    
    $
    —
    
    $
    —
    
    $
    —
 
 The
components of future income taxes are as follows:
  December
      31,
    
    2004
    
    2003
    
    2002Capital
      assets
    
    $
    102,294
    
    $
    51,629
    
    $
    202,637Software
      development costs
    
    
    (496,898
    )
    
    (96,645
    )
    
    98,226Patents
    
    
    17,033
    
    
    24,840
    
    
    40,151Share
      issue costs
    
    
    181,667
    
    
    167,438
    
    
    294,222Other
    
    
    56,858
    
    
    8,801
    
    
    35,380Loss
      carryforwards
    
    
    18,997,435
    
    
    14,353,867
    
    
    13,710,621Valuation
      allowance
    
    
    (18,858,389
    )
    
    (14,509,930
    )
    
    (14,381,237
    )Net
      future income tax asset
    
    $
    —
    
    $
    —
    
    $
    —
  The
Company provided a full valuation allowance against the future income tax assets
based on the Company’s evaluation of the likelihood of realization of these
assets. The Company will continue to evaluate and examine the valuation
allowance on a regular basis.
  At
December 31, 2004, the Company and its subsidiaries ("the Group") have
non-capital losses of $26,215,758 and net capital losses of $5,490,077 which are
available to reduce Canadian taxable income in future years.
  In China,
our Zi Technology related subsidiary, Huayu Zi Software Technology (Beijing) Co.
Ltd has taxable income in excess of loss carryforwards from prior years. The
Company is applying for tax holidays with Chinese tax authorities that more than
likely will result in no tax due for the years 2004 and 2005 and 50 percent of
tax payable for the years 2006, 2007 and 2008. The amount of tax that would
otherwise be payable in 2004 is $166,871 and has not been accrued.
   F-17
 
 Operating
loss carryforwards for each of the countries listed below will expire as
follows:
  Year
      of expiry
    Canadiannon-capital losses2005
    $
    436,3452006
    $
    132,3712007
    $
    1,319,7792008
    $
    615,0282009
    $
    3,941,9292010
    $
    11,499,4032011
    $
    4,406,0472012
    $
    3,864,856Total
    $
    26,215,758
  Year of expiry(Federal)
    US
      non-operating
      losses2017
    $
    720,5532018
    $
    225,9662019
    $
    255,2002020
    $
    2,171,1802021
    $
    1,468,3552022
    $
    —2023
    $
    572,8192024
    $
    5,747Total
    $
    5,419,820
  Year of expiry(California)
    US non-operating
      losses
 2010
    $
    1,194,1492011
    $
    807,5952012
    $
    —2013
    $
    343,6912014
    $
    5,747Total
    $
    2,351,182Year of expiry
    China operating
      losses2007
    $
    565,2092008
    $
    1,634,7522009
    $
    777,8782010
    $
    2,487,927Total
    $
    5,465,766
 
 The Group
also has non-capital losses for Hong Kong tax purposes of $34,013,846. These
losses may be carried forward indefinitely.
  12.
    Contingent
Liabilities
 
 On
December 4, 2003, the Company commenced action against Morrison & Foerster
LLP ("MoFo") in the Superior Court of the State of California, County of San
Francisco claiming (i) professional negligence based on MoFo's failure to
exercise reasonable care, skill and diligence in representing the Company in the
defense of Asian Communication Pty Ltd and Tegic Communications Inc. ("Tegic")
v. Zi Corporation and Zi Corporation of America, Inc. (a patent infringement
lawsuit) and (ii) reimbursement of the payments made to MoFo in connection with
the defense of this lawsuit, which payments are alleged to exceed the reasonable
value of MoFo's services and costs advanced. MoFo has filed, as part of its
defence to the Company's action, a cross complaint against the Company for
unpaid legal fees and costs. Although the Company believes that it will prevail
in this action, in 2002, the Company accrued $1,061,617 representing the
previously billed fees and costs. Accordingly, the Company believes that any
further exposure from this action is limited to accrued interest and
costs.
   F-18
  The $9
million damages judgement awarded to Tegic was settled pursuant to a written
settlement agreement with AOL Time Warner dated December 6, 2002 and a consent
judgement dated December 20, 2002. Settlement costs were included as part of
legal and litigation costs and as at December 31, 2003 was $0.75 million, which
was paid on January 2, 2004 to AOL.
  From time
to time, the Company is involved in other claims in the normal course of
business. Management assesses such claims and where it is not probable to result
in a material exposure and where the amount of the claim is quantifiable,
provisions for loss are made based on management’s assessment of the likely
outcome. The Company does not provide for claims that are unlikely to result in
a significant loss, claims for which the outcome is not determinable or claims
where the amount of the loss cannot be reasonably estimated. Any settlements or
awards under such claims are provided for when reasonably
determinable.
  13.
    Related Party
Transactions
 
 The
following table outlines the Company’s related party transactions:
  2004
    
    2003
    
    2002Legal
      services provided by two law firms in which a director is and was a
      partner
    
    $
    125,708
    
    $
    110,373
    
    $
    145,567Due
      from significantly influenced company
    
    $
    10,442
    
    $
    33,187
    
    $
    —Consulting
      fees paid to a firm owned by a director
    
    $
    30,000
    
    $
    120,000
    
    $
    120,000Consulting
      fees paid to a firm owned by an officer
    
    $
    46,067
    
    $
    26,136
    
    $
    4,539
  These
transactions are in the normal course of operations and are measured at their
exchange value, which approximates the fair market value as with any third
party.
  At the
year-end, the amounts due from (to) related parties are as follows:
  2004
    
    2003
    
    2002Due
      to law firm in which a director is a partner
    
    $
    (5,338
    )
    $
    (411
    )
    $
    (15,250
    )Due
      from significantly influenced company
    
    $
    43,629
    
    $
    33,187
    
    $
    —Due
      to companies owned by a director or officer
    
    $
    —
    
    $
    (10,000
    )
    $
    (10,000
    )
  In 2002,
a private company owned by an officer, who is also a director of the Company,
guaranteed the note payable by the Company through a limited recourse guarantee
and share pledge agreement (note 7).
  On
November 7, 2002, the Company completed the sale of Magic Lantern to JKC Inc., a
related party (note 3). The companies are related through a common significant
shareholder.
  14.
    Commitments and
Guarantees
 
 The
Company rents premises and equipment under operating leases, which expire at
various dates up to June 2007. The Company recorded rent expense for 2004 of
$480,575 (2003 - $747,023; 2002 - $1,274,582).
  Annual rentals under
      these leases for each of the next five years are as
    follows:2005
    
    $
    618,6802006
    
    
    538,4072007
    
    
    194,7112008
    
    
    —2009
    
    
    —Total
    
    $
    1,351,798
  From time
to time the Company enters into certain types of contracts that require it to
indemnify parties against possible third party claims particularly when these
contracts relate to licensing agreements. On occasion the Company may provide
indemnities. The terms of such obligations vary and generally, a maximum is not
explicitly stated. Because the financial obligations in these agreements are
often not explicitly stated, the overall maximum amount of the obligations
cannot be reasonably estimated. Historically, the Company has not been obligated
to make significant payments for these indemnification obligations. The
Company’s management actively monitors the Company’s exposure to the above risks
and obtains insurance coverage to satisfy potential or future claims as
necessary.
   F-19
  15.
    Segmented
Information
 
 Zi
Corporation develops software designed to enhance the usability of mobile and
consumer electronic devices through its Zi Technology business segment. Zi
Technology’s core technology product, eZiText, is a predictive text input
solution that predicts words and/or phrases for use in messaging and other text
applications in over 48 languages and dialects. By offering word candidates as
text is being entered, eZiText increases the ease, speed and accuracy of text
input on any electronic device for applications such as short messaging, e-mail,
e-commerce and Web browsing. Revenues are reported under the contracting Zi
subsidiary’s country of residence.
  Through
its e-Learning business segment which includes Oztime, English Practice and an
equity interest in Magic Lantern Group, Inc., the Company is also involved in
e-Learning technology, content and customer service as well as educational
content and distribution channels to offer learning management systems,
interactive online courses and network education solutions to meet diverse
client requirements.
  Other
includes unallocated segment expenses such as legal fees, public company costs,
interest and other income and head office costs. The accounting policies of each
of the business segments are the same as those described in note 2.
  The
Company’s primary operations are located in North America. The Company operates
three reportable geographic segments through three reportable business
segments:
  Revenue
    
    
    
    
    
    Operating profit(loss),
      beforeLicense
      and implementation fees
    
    Software
      and other
    
    Total
    
    Amortization
    
    Other
      operatingexpenses
    
    interest
      andother income2004Zi
      Technology
    
    $
    12,898,838
    
    $
    —
    
    $
    12,898,838
    
    $
    709,064
    
    $
    7,915,192
    
    $
    4,274,582e-Learning
    
    
    —
    
    
    504,213
    
    
    504,213
    
    
    24,646
    
    
    3,223,272
    
    
    (2,743,705
    )Other
    
    
    —
    
    
    —
    
    
    —
    
    
    193,176
    
    
    3,798,053
    
    
    (3,991,229
    )Total
    
    $
    12,898,838
    
    $
    504,213
    
    $
    13,403,051
    
    $
    926,886
    
    $
    14,936,517
    
    $
    (2,460,352
    )Interest
      expense and interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    72,153Loss
      from continuing operations before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (
      2,388,199
    )2003Zi
      Technology
    
    $
    9,918,998
    
    $
    —
    
    $
    9,918,998
    
    $
    1,124,047
    
    $
    6,928,139
    
    $
    1,866,812e-Learning
    
    
    —
    
    
    684,070
    
    
    684,070
    
    
    75,042
    
    
    1,400,830
    
    
    (791,802
    )Other
    
    
    —
    
    
    —
    
    
    —
    
    
    181,176
    
    
    3,229,712
    
    
    (3,410,888
    )Total
    
    $
    9,918,998
    
    $
    684,070
    
    $
    10,603,068
    
    $
    1,380,265
    
    $
    11,558,681
    
    $
    (2,335,878
    )Interest
      expense and interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (595,231
    )Loss
      from continuing operations before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (2,931,109
    )2002Zi
      Technology
    
    $
    6,480,938
    
    $
    —
    
    $
    6,480,938
    
    $
    1,642,053
    
    $
    5,474,457
    
    $
    (635,572
    )e-Learning
    
    
    —
    
    
    1,935,309
    
    
    1,935,309
    
    
    449,630
    
    
    8,429,007
    
    
    (6,943,328
    )Other
    
    
    —
    
    
    —
    
    
    —
    
    
    134,889
    
    
    11,752,406
    
    
    (11,887,295
    )Total
    
    $
    6,480,938
    
    $
    1,935,309
    
    $
    8,416,247
    
    $
    2,226,572
    
    $
    25,655,870
    
    $
    (19,466,195
    )Interest
      expense and interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32,230
    )Loss
      from continuing operations before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (19,498,425
    )
  2004
    
    
    
    
    
    
    
    
    2003Capital
      assets
    
    
    Other
      assets
    
    
    Identifiableassets
    
    
    Capital
      assets
    
    
    Other
      assets
    
    
    IdentifiableassetsZi
      Technology
    
    $
    2,092,519
    
    $
    6,375,647
    
    $
    8,468,166
    
    $
    1,057,310
    
    $
    4,424,208
    
    $
    5,481,518e-Learning
    
    
    30,879
    
    
    1,016,799
    
    
    1,047,678
    
    
    92,664
    
    
    559,467
    
    
    652,131Other
    
    
    656,646
    
    
    11,526,381
    
    
    12,183,027
    
    
    715,501
    
    
    3,836,428
    
    
    4,551,929Total
    
    $
    2,780,044
    
    $
    18,918,827
    
    $
    21,698,871
    
    $
    1,865,475
    
    $
    8,820,103
    
    $
    10,685,578
 
 
 F-20
 
 The
investment in significantly influenced subsidiary and its associated 2002 equity
loss of $220,687 have been included as part of the e-Learning business segment
and as part of the Canadian geographic segment (note 10). Other includes
non-cash compensation expense related to issuance of non-employee stock options
and RSU’s in 2004 of $1,371,398 (2003 - $516,354; 2002 - $nil) and non-cash
interest expense of $nil (2003 - $95,344; 2002 - $nil). All additions to
software development costs of $1,661,974 in 2004 (2003- $237,618) are part of Zi
Technology operations.
   Revenue
    
    
    
    
    
    Operating profit
      (loss),
      beforeLicense and
      implementation
      fees
    
    Software
      and other
    
    Total
    
    Amortization
    
    Other
      operatingexpenses
    
    interest
      andother income2004Canada
    
    $
    5,884,396
    
    $
    8,120
    
    $
    5,892,516
    
    $
    785,332
    
    $
    9,087,566
    
    $
    (3,980,382
    )China
    
    
    5,207,579
    
    
    496,093
    
    
    5,703,672
    
    
    111,477
    
    
    3,870,783
    
    
    1,721,412USA
    
    
    1,806,863
    
    
    —
    
    
    1,806,863
    
    
    15,681
    
    
    1,868,755
    
    
    (77,573
    )Other
    
    
    —
    
    
    —
    
    
    —
    
    
    14,396
    
    
    109,413
    
    
    (123,809
    )Total
    
    $
    12,898,838
    
    $
    504,213
    
    $
    13,403,051
    
    $
    926,886
    
    $
    14,936,517
    
    $
    (2,460,352
    )Interest
      expense and interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    72,153Loss
      from continuing operations before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (
      2,388,199
    )2003Canada
    
    $
    3,731,859
    
    $
    13,982
    
    $
    3,745,841
    
    $
    1,027,630
    
    $
    5,649,385
    
    $
    (2,931,174
    )China
    
    
    3,378,770
    
    
    670,088
    
    
    4,048,858
    
    
    298,575
    
    
    3,731,641
    
    
    18,642USA
    
    
    2,808,369
    
    
    —
    
    
    2,808,369
    
    
    34,689
    
    
    2,031,146
    
    
    742,534Other
    
    
    —
    
    
    —
    
    
    —
    
    
    19,371
    
    
    146,509
    
    
    (165,880
    )Total
    
    $
    9,918,998
    
    $
    684,070
    
    $
    10,603,068
    
    $
    1,380,265
    
    $
    11,558,681
    
    $
    (2,335,878
    )Interest
      expense and interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (595,231
    )Loss
      from continuing operations before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (2,931,109
    )2002Canada
    
    $
    2,315,344
    
    $
    1,638,898
    
    $
    3,954,242
    
    $
    1,477,856
    
    $
    15,463,984
    
    $
    (12,987,598
    )China
    
    
    1,368,614
    
    
    296,411
    
    
    1,665,025
    
    
    707,468
    
    
    7,093,291
    
    
    (6,135,734
    )USA
    
    
    2,796,980
    
    
    —
    
    
    2,796,980
    
    
    25,059
    
    
    2,575,327
    
    
    196,594Other
    
    
    —
    
    
    —
    
    
    —
    
    
    16,189
    
    
    523,268
    
    
    (539,457
    )Total
    
    $
    6,480,938
    
    $
    1,935,309
    
    $
    8,416,247
    
    $
    2,226,572
    
    $
    25,655,870
    
    $
    (19,466,195
    )Interest
      expense and interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32,230
    )Loss
      from continuing operations before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (19,498,425
    )
  2004
    
    
    
    
    
    2003Capital
      assets
    
    Other
      assets
    
    Identifiableassets
    
    Capital
      assets
    
    Other
      assets
    
    Identifiable
      assetsCanada
    
    $
    2,408,257
    
    $
    15,920,950
    
    $
    18,329,207
    
    $
    1,354,833
    
    $
    5,534,387
    
    $
    6,889,220China
    
    
    213,375
    
    
    2,215,414
    
    
    2,428,789
    
    
    330,534
    
    
    2,548,453
    
    
    2,878,987USA
    
    
    50,441
    
    
    750,474
    
    
    800,915
    
    
    57,740
    
    
    706,897
    
    
    764,637Other
    
    
    107,971
    
    
    31,989
    
    
    139,960
    
    
    122,368
    
    
    30,366
    
    
    152,734Total
    
    $
    2,780,044
    
    $
    18,918,827
    
    $
    21,698,871
    
    $
    1,865,475
    
    $
    8,820,103
    
    $
    10,685,578
  In 2004,
two Zi Technology customers accounted 34 percent or $4,587,871 (2003 - 26
percent or $2,719,936; 2002 - 25 percent or $2,135,960) of the Company’s total
revenue. Canada includes non-cash compensation expense related to issuance of
non-employee stock options and RSU’s in 2004 of $1,371,398 (2003 - $516,354;
2002 - $nil) and non-cash interest expense of $nil (2003 — $95,344; 2002 -
$nil). All additions to software development costs of $1,661,974 in 2004 (2003 -
$237,618) are part of Canadian operations.
   F-21
  16.
    Canadian Generally Accepted Accounting
      Principles
 
 The
consolidated financial statements, prepared in accordance with US GAAP, conform
to Canadian GAAP, in all material respects, except:
  Start-up
costs
  Pursuant
to Canadian GAAP Emerging Issues Committee ("EIC") Abstract 27, “Revenues and
Expenditures During the Pre-Operating Period", certain costs of start-up
activities and organizational costs are capitalized as incurred as long as the
expenditure is directly related to placing the new business into service, is
incremental in nature and recoverable through future operations. Start-up costs
include those one-time activities related to organizing a new entity.
Consequently, start-up costs associated with the 1999 acquisition of Beijing Oz
Education Network Ltd. ("Oztime") of $205,842 have been capitalized. Related
amortization charges recorded pursuant to Canadian GAAP are included in income
under Canadian GAAP.
  Share
capital
  Under
Canadian GAAP, the December 31, 1997 stated capital of the Company was reduced
by its December 31, 1996 deficit of $24,339,036. US GAAP does not allow for such
restatement. This reclassification has no effect on net shareholders’ equity as
at December 31, 2002, 2003 and 2004.
  Shares
outstanding used to compute per share figures under Canadian GAAP are as
follows:
  2004
    
    2003
    
    2002Weighted
      average number of shares
    
    
    41,373,309
    
    
    38,719,786
    
    
    37,767,000
  Foreign
currency translation
  Under
Canadian GAAP, the Company, on a consolidated basis, is required, for the years
ended December 31, 2002, 2003 and 2004, to translate the accounts of its
subsidiaries to US dollars using the temporal method. The accounts of the
Company’s integrated operations in foreign subsidiaries are translated into US
dollars using the temporal method whereby monetary items are translated at the
rate of exchange in effect at the balance sheet date and non-monetary items are
translated at applicable historical rates. The resulting foreign exchange gain
or loss on translation is included as part of the calculation of the net loss as
compared to inclusion as part of other comprehensive income disclosed on the
statement of shareholders equity under US GAAP.
  Consolidated
statement of loss
  The
application of Canadian GAAP would have the following effects on net loss as
reported:
  2004
    
    2003
    
    2002Restated
      (2)Net
      loss from continuing operations as reported in accordance with US
      GAAP
    
    $
    (2,388,199
    )
    $
    (2,931,109
    )
    $
    (19,498,425
    )Adjustments:Start-up
      costs amortization
    
    
    —
    
    
    —
    
    
    (116,322
    )Fair
      value of stock options issued
    
    
    (1,624,153
    )
    
    (1,679,224
    )
    
    —Foreign
      exchange gain
    
    
    275,834
    
    
    162,453
    
    
    158,641Total
      adjustments
    
    
    (1,348,319
    )
    
    (1,516,771
    )
    
    42,319Net
      loss from continuing operations under Canadian GAAP
    
    $
    (3,736,518
    )
    $
    (4,447,880
    )
    $
    (19,456,106
    )Loss
      from discontinued operations
    
    
    —
    
    
    —
    
    
    (5,707,850
    )Net
      loss under Canadian GAAP
    
    $
    (3,736,518
    )
    $
    (4,447,880
    )
    $
    (25,163,956
    )Loss
      from continuing operations per share under Canadian GAAP, basic and
      diluted
    
    $
    (0.09
    )
    $
    (0.12
    )
    $
    (0.52
    )Loss
      from discontinued operations per share under Canadian GAAP
    
    
    —
    
    
    —
    
    
    (0.15
    )Loss
      per share under Canadian GAAP, basic and diluted
    
    $
    (0.09
    )
    $
    (0.12
    )
    $
    (0.67
    )
  (2) At
December 31, 2004, the Company’s stock based compensation expense has been
reallocated to better reflect the variety of vesting periods of its stock option
grants. In 2003, the determination of the stock based compensation expense was
based on amortization periods that did not best reflect the variety of vesting
periods for the associated stock option grants. Accordingly, the Company has
restated the 2003 stock compensation expense and appropriate related balances as
follows:
   F-22
  2003Net
      loss as previously stated
    
    $
    (5,021,508
    )Fair
      value of stock options issued as previously stated
    
    
    2,252,852Restatement
      of stock compensation expense
    
    
    (1,679,224
    )Restated
      net loss
    
    $
    (4,447,880
    )Net
      loss per share as previously stated, basic and diluted
    
    $
    (0.13
    )Restatement
      of stock compensation expense, basic and diluted
    
    
    0.01Restated
      net loss per share, basic and diluted
    
    $
    (0.12
    )
  Stock-based
compensation
  Effective
January 1, 2002, under Canadian GAAP, the Company was required to adopted
Section 3870, “Stock-based Compensation and Other Stock-based Payments", which
recommends that awards to employees be valued using the fair value method of
accounting. These rules also require that companies account for stock
appreciation rights ("SARs") and similar awards to be settled in cash or other
assets, by measuring compensation expense on an ongoing basis, as the amount by
which the quoted market price exceeds the exercise price at each measurement
date.
  The
Company has a stock-based compensation plan, which is described in note 9. Under
Canadian GAAP, the Company has elected to account for stock options by measuring
compensation expense as the excess, if any, of the quoted market value of the
stock at the date of grant over the exercise price. Any consideration paid by
employees on exercise of stock options or purchase of stock is credited to share
capital. If stock or stock options are repurchased from employees, the excess of
the consideration paid over the carrying amount of the stock or stock option
cancelled is charged to retained earnings.
  Under the
Canadian Institute of Chartered Accountants’ ("CICA’s) Handbook section 3870,
companies that elect a method other than the fair value method of accounting are
required to disclose pro forma net income and earnings per share information,
using a pricing model such as the Black-Scholes model, as if the fair value
method of accounting had been used. These new rules do not apply to pre-existing
awards except for those awards that call for settlement in cash or other assets.
  In
September 2003, the CICA issued an amendment to CICA Handbook Section 3870
“Stock-Based Compensation and Other Stock—Based Payments". The amendment
provides two alternative methods of transition to the fair-value method of
accounting for stock-based employee compensation - prospective and retroactive
methods. The Canadian amendment only applies to voluntary transitions before
January 1, 2004. The Company adopted the fair-value method of accounting for
stock options in the fourth quarter of 2003. The Company has adopted the
fair-value based method prospectively, whereby compensation cost is recognized
for all options granted on or after January 1, 2003.
  Under the
fair value method, the pro forma effect on the Company’s net loss and net loss
per share in 2002 is as follows:
  Compensation
      Costs
    Year
      ended December 31, 2002Net
      loss under Canadian GAAP:
    
    $
    (25,163,956
    )Add:
      Stock option expense
    
    
    (383,162
    )Net
      loss under Canadian GAAP, pro forma
    
    $
    (25,547,118
    )Basic
      net loss per share and pro forma
    
    $
    (0.68
    )
  Consolidated
balance sheets
  The
application of Canadian GAAP would have the following effects on balance sheet
items as reported:
  SHAREHOLDERS’
      EQUITY
    
    2004
    
    2003
    
    2002Restated
      (3)Shareholders’
      equity under Canadian GAAP, beginning of year
    
    $
    2,601,869
    
    $
    3,654,888
    
    $
    27,619,818Share
      capital issued and contributed surplus
    
    
    13,580,428
    
    
    3,394,861
    
    
    1,199,026Net
      loss from continuing operations under US GAAP
    
    
    (2,388,199
    )
    
    (2,931,109
    )
    
    (19,498,425
    )Net
      loss from discontinued operations under US GAAP
    
    
    —
    
    
    —
    
    
    (5,707,850
    )Adjustments
      to net loss for the year under Canadian GAAP
    
    
    (1,348,319
    )
    
    (1,516,771
    )
    
    42,319Shareholders’
      equity under Canadian GAAP, end of year
    
    $
    12,445,779
    
    $
    2,601,869
    
    $
    3,654,888
  (3) Per
discussion in footnote (2) above, 2003 Shareholders equity under Canadian GAAP
has been restated from $2,028,241 to $2,601,869.
   F-23
  Canadian
GAAP Comparative Consolidated Financial Statements
  The
following financial statements for the years ended December 31, 2002 are as
previously disclosed in accordance with Canadian GAAP and in Canadian
dollars.
  CONSOLIDATED
STATEMENTS OF LOSS AND DEFICIT
  Year
      ended December 31
    
    2002RevenueLicense
      and implementation fees
    
    $
    10,166,562Other
      product revenue
    
    
    3,037,03513,203,597Cost
      of salesLicense
      and implementation fees
    
    
    394,749Other
    
    
    1,233,3121,628,061Gross
      margin
    
    
    11,575,536Operating
      expensesSelling
      general and administrative
    
    
    (17,849,562
    )Litigation
      and legal
    
    
    (11,794,981
    )Product
      research and development
    
    
    (4,365,803
    )Depreciation
      and amortization
    
    
    (3,879,913
    )Impairment
      of goodwill
    
    
    (1,976,908
    )Impairment
      of intangible assets
    
    
    (2,424,694
    )Foreign
      exchange gain
    
    
    42,088Operating
      loss before undernoted
    
    
    (30,674,237
    )Interest
      on long term debt
    
    
    (139,046
    )Other
      interest
    
    
    (439,765
    )Interest
      income and other income
    
    
    286,429Equity
      interest in loss of significantly influenced company
    
    
    (343,402
    )Loss
      from continuing operations before income taxes
    
    
    (31,310,021
    )Income
      taxes
    
    
    —Loss
      from continuing operations
    
    
    (31,310,021
    )Discontinued
      operationsLoss
      from discontinued operations
    
    
    (9,077,079
    )Net
      loss
    
    
    (40,387,100
    )Deficit,
      beginning of year
    
    
    (50,994,973
    )Deficit,
      end of year
    
    $
    (91,382,073
    )Basic
      and diluted loss from continuing operations per share
    
    $
    (0.83
    )Loss
      from discontinued operations per share
    
    
    (0.24
    )Basic
      and diluted loss per share
    
    $
    (1.07
    )Weighted
      average common shares
    
    
    37,767,000Common
      shares outstanding, end of period
    
    
    37,914,250
 
  F-24
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
  Year
      ended December 31
    
    2002Operating
      activities:Net
      loss
    
    $
    (31,310,021
    )Items
      not affecting cash:Loss
      (gain) on dispositions of capital assets
    
    
    330,194Depreciation
      and amortization
    
    
    3,879,913Impairment
      of goodwill
    
    
    1,976,908Impairment
      of intangible assets
    
    
    2,424,694Interest
      expense
    
    
    240,573Equity
      in net loss of significantly influenced company
    
    
    343,402Funds
      applied to operations
    
    
    (22,114,337
    )Decrease
      in non—cash working capital
    
    
    1,896,595Cash
      flow applied to operations
    
    
    (20,217,742
    )Financing
      activities:Proceeds
      from issuance of common shares
    
    
    1,117,446Issuance
      of note payable
    
    
    5,127,910Payment
      of capital lease obligations
    
    
    (143,080
    )6,102,276Investing
      activities:Short-term
      investments
    
    
    8,577,503Purchase
      of capital assets
    
    
    (1,060,012
    )Proceeds
      from capital dispositions
    
    
    50,964Software
      development costs
    
    
    (978,161
    )Other
      deferred costs
    
    
    (60,000
    )Acquisition
      of subsidiaries net of bank indebtedness
    
    
    (1,884,433
    )Sale
      of subsidiary net of cash given up
    
    
    (548,461
    )4,097,400Discontinued
      operations
    
    
    (3,730,127
    )Net
      cash (outflow) inflow
    
    
    (13,748,193
    )Cash
      and cash equivalents, beginning of year
    
    
    19,090,964Cash
      and cash equivalents, end of year
    
    $
    5,342,771Non
      cash financing activityEquipment
      acquired under capital lease
    
    $
    34,200Patent
      acquired through share issuance
    
    $
    —Acquisition
      of subsidiary
    
    $
    513,500Components
      of cash and cash equivalentsCash
    
    $
    5,342,771Cash
      equivalents
    
    $
    —Supplemental
      cash flow informationCash
      paid for interest
    
    $
    136,888Cash
      paid for income taxes
    
    $
    —
   F-25
 
 New
accounting standards
  The
following guidelines issued by the CICA did not or are not expected to impact
the Company:
  In late
2003, the of the CICA issued EIC—141, “Revenue Recognition”, EIC-142, “Revenue
Arrangements with Multiple Deliverables” and EIC-143, “Accounting for Separately
Priced Extended Warranty and Product Maintenance Contracts”. The EIC guidelines
provide interpretive guidance for applying the standards in Section 3400 Revenue
of the CICA Handbook and bring Canadian standards in line with U.S. standards.
The new guidance had no impact on the Company as we report under US GAAP
already.
  During
2004, we adopted the new CICA Handbook sections 1100, “Generally Accepted
Accounting Principles”, and 1400, “General Standards of Financial Statement
Presentation”. These sections outline standards for fair presentation in
financial reporting and describe what constitutes Canadian GAAP and its sources.
The adoption of these standards had no significant impact on the Company’s
consolidated financial statements.
  Section
3063, “Impairment of Long-lived Assets” of the CICA Handbook became effective
for our 2004 fiscal year. The standard provides guidance on recognizing,
measuring and disclosing the impairment of long-lived assets and replaces the
previous standard for write-downs of property, plant and equipment. The adoption
of the standard had no significant impact to the Company.
  Section
3461, “Employee Future Benefits” of the CICA handbook was amended in 2004 to
require greater disclosure with respect to employer’s pension plans and other
employer future benefit plans. The amendments to this standard do not include
any changes to any of the recognition or measurement requirements. The adoption
of these standards had no significant impact on the Company’s consolidated
financial statements.
  Effective
in 2005, Accounting Guideline 15, “Consolidation of Variable Interest Entities”,
which requires consolidation of certain entities that are subject to control on
a basis other than ownership of voting interests, called variable interest
entities ("VIE’s"). The new guidance had no impact on the Company as we report
under US GAAP which includes similar VIE requirements.
  17.
    Supplemental Financial
  Information
 
 Accrued
liabilities
  The
following items are included in the accounts payable and accrued liabilities
balance:
  Accounts
      payable and accrued liabilities
    
    2004
    
    2003Trade
      accounts payable
    
    $
    545,228
    
    $
    442,788Litigation
      and legal
    
    
    1,120,130
    
    
    2,037,644Compensation
    
    
    1,011,397
    
    
    1,118,735Other
      accrued liabilities
    
    
    404,525
    
    
    500,140Total
    
    $
    3,081,280
    
    $
    4,099,307
  Non-cash
working capital
  The
following balances are included as part of non-cash working
capital:
  Non-cash
      working capital
    
    2004
    
    2003
    
    2002Accounts
      receivable
    
    $
    (1,561,047
    )
    $
    (1,213,608
    )
    $
    (1,123,702
    )Work-in-progress
      and inventory
    
    
    —
    
    
    97,455
    
    
    151,085Prepayments
      and deposits
    
    
    (15,227
    )
    
    303,880
    
    
    (117,147
    )Accounts
      payable and accrued liabilities
    
    
    (1,018,027
    )
    
    (151,974
    )
    
    2,271,409Deferred
      revenue
    
    
    1,604,532
    
    
    593,639
    
    
    20,494(Decrease)
      increase in non-cash working capital
    
    $
    (989,769
    )
    $
    (370,608
    )
    $
    1,202,139
  Loss per
share
  In 2004,
anti-dilutive stock options, RSU’s, warrants and performance based escrowed
shares of 6,374,836 have been excluded in the calculation of diluted loss per
share (2003 - 6,014,904; 2002 - 5,310,700).
  18.
    Reclassifications
 
 Certain
amounts have been reclassified to conform with the presentation adopted in the
current year.
   F-26
  19.
    Subsequent Events
 
 In
January 2005, the Company purchased the assets of Decuma AB ("Decuma"), a
Swedish company specializing in developing and marketing handwriting recognition
software. As part of the acquisition, the Company acquired Decuma’s intellectual
property and customer agreements. The purchase price included 146,929 common
shares with a value of $1.0 million and cash consideration of $175,254 less
direct costs of the purchase.
  The
estimated purchase price is allocated as follows:
  Net
      assets acquired:Non-cash
      working capital
    
    $
    (15,451
    )Capital
      assets
    
    
    50,201Patents
      and trademarks
    
    
    896,120$
    930,870
 
  F-27
 ****
 **REPORT
OF INDEPENDENT REGISTERED CHARTERED** **ACCOUTANTS**
  To the
Shareholders of Zi Corporation
  We have
audited the consolidated financial statements of Zi Corporation (the ''Company'')
as of December 31, 2004 and 2003, and for each of the three years in
the period
ended December 31, 2004, and have issued our reports thereon dated March 11,
2005; such financial statements and reports are included in the 2004 Annual
Report on Form 20-F. Our audits also included the financial statement schedule
of Zi Corporation. This financial statement schedule is the responsibility of
the Company's management. Our
responsibility is to express an opinion based on our audits. In our opinion,
the financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, present fairly, in all material respects, the
information set forth therein.
  
  (signed)
"Deloitte & Touche LLP"
   Independent
Registered Chartered Accountants
 Calgary,
Alberta, Canada
 March 11,
2005
 
  **Schedule
11 - Valuation and Qualifying Accounts**
  Balance
      at Beginning of Year
    
    Charged
      to costsand
      expenses
    
    Balance
      atDeductions
    
    End
      of YearAllowance
      for Doubtful AccountsYear
      Ended December 31, 2004
    
    $
    507,
      640
    
    $
    68,844
    
    $
    422,376
    
    $
    154,108Year
      Ended December 31, 2003
    
    $
    247,062
    
    $
    260,578
    
    
    
    
    $
    507,640Year
      Ended December 31, 2002
    
    $
    —
    
    $
    247,062
    
    $
    —
    
    $
    247,062
 
  
 
  F-28