UNITED STATES 
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

FORM 20-F/AAmendment No. 1

|(Mark One)                                                                                          
|----------------------------------------------------------------------------------------------------
|                                                                                                    
|oREGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR
    (g) OF THE SECURITIES EXCHANGE ACT OF 1934 
|                                                                                                    
|OR                                                                                                  
|                                                                                                    
|ýANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934           
|For the fiscal year
    ended December 31, 2006                                                     
|                                                                                                    
|OR                                                                                                  
|                                                                                                    
|oTRANSITION
    REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
    1934   
|                                                                                                    
|OR                                                                                                  
|                                                                                                    
|oSHELL COMPANY
    REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
    1934
|Date of event
    requiring this shell company report...................                            
|                                                                                                    
|For the transition period from
    ___________________________ to _______________________           

Commission file number 000-24018

|ZI CORPORATION                                           
|---------------------------------------------------------
|(Exact name of Registrant as specified in its charter)   
|                                                         
|N/A                                                      
|(Translation of Registrant's name into English)          
|                                                         
|Alberta, Canada                                          
|(Jurisdiction of incorporation or organization)          
|                                                         
|2100, 840 - 7th Avenue 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.

|Title of each
    class     |  | Name of each
    exchange on which registered
|--------------------------- |  | ---------------------------------------------
|Common Shares, no par value |  | NASDAQ Global Market                         

Securities registered or to be registered pursuant to Section 12(g) of the
Act.

|None            
|----------------
|(Title of Class)

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Securities for which there is a reporting obligation pursuant to Section
15(d) of the Act.None(Title of Class)Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of December 31, 2006.46,688,624Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
(  ) Yes     (X) No
If this report is an annual or transition report, indicate by check mark if
the registrant is not required to file reports pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934.
(  ) Yes     (X ) No
Note  Checking the box above will not relieve any registrant required to
file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934 from their obligations under those Sections.
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     (  ) No
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
One):Large accelerated filer
    
    Accelerated filer
    
    Non-accelerated filer
    XIndicate by check mark which financial statement item the registrant has
elected to follow.
(  ) Item 17      (X) Item 18
If this is an annual report, indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
(  ) Yes      (X) No
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PAST FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
(  ) Yes      (  ) No

2

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TABLE OF CONTENTS

|PART I                                                      | 5 
|----------------------------------------------------------- | --
|Item 3. Key Information                                     | 5 
|A.Selected financial data                                   | 5 
|Currency and Exchange Rates                                 | 6 
|B. Capitalization and Indebtedness                          | 6 
|C. Reasons for the offer and use of proceeds                | 6 
|D. Risk factors                                             | 6 
|Item 4. Information on the Company                          | 16
|A. History and Development of the Company                   | 16
|Acquisition and Development of Input Technology             | 16
|Acquisition and Divestiture of Oztime                       | 18
|Acquisition and Divestiture of EnglishPractice
    Inc.     | 19
|Acquisition of Archer Education Group Inc.                  | 19
|Acquisition of Assets of Decuma AB                          | 20
|Intellectual Property Litigation                            | 20
|Disposition and Discontinued Operations                     | 21
|Telecom Technology Corporation Limited                      | 21
|The Magic Lantern Group of Companies                        | 21
|Archer Education Group Inc                                  | 22
|Acquisition of Zi Shares by the Lancer Funds                | 22
|Principal Capital Expenditures and Divestitures             | 24
|B. Business overview                                        | 25
|Zi in General                                               | 25
|Zi Technology Business Unit                                 | 25
|Description of eZiText and eZiType                          | 25
|Licensing of eZiText                                        | 27
|Description of Qix                                          | 27
|Description of Decuma Handwriting Recognition
    Solutions | 27
|Investment in Archer Education Group Inc.                   | 28
|Geographic Segments                                         | 29
|C. Organizational Structure                                 | 29
|D. Property, plants and equipment                           | 30
|Item 5. Operating and Financial Review and
    Prospects    | 30
|A. Operating results                                        | 31
|Recent Developments                                         | 32
|Critical Accounting Policies and Estimates                  | 32
|Going Concern Basis                                         | 33
|Software Development Costs                                  | 33
|Revenue Recognition                                         | 33
|Stock-Based Compensation Plan                               | 33
|Contingencies                                               | 34
|Accounting for Income Taxes                                 | 34
|Recent accounting pronouncements                            | 34
|Quarterly Overview                                          | 35
|Operating Results                                           | 37

3

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|Net Loss                                                                            | 37
|----------------------------------------------------------------------------------- | --
|Revenue                                                                             | 38
|Cost of Sales & Gross Margin                                                        | 39
|Selling, General and Administrative Expenses                                        | 39
|Legal                                                                               | 40
|Product Research and Development Expense                                            | 40
|Depreciation and Amortization                                                       | 41
|Interest and Other Income                                                           | 41
|Income Tax Expense                                                                  | 41
|Discontinued Operations                                                             | 42
|Foreign Currency                                                                    | 42
|Impact on Governmental Policies and Other Factors
    on Operations and Investments | 42
|B. Liquidity and capital resources                                                  | 42
|Financial Condition and Liquidity                                                   | 43
|Restricted Cash                                                                     | 43
|Bank Indebtedness                                                                   | 43
|Cash Requirements Outlook                                                           | 43
|Cash applies to Operating Activities                                                | 43
|Financing Activities                                                                | 44
|Investing Activities                                                                | 44
|Commitments and Contractual Obligations                                             | 44
|Transactions with Related Parties                                                   | 45
|Off-Balance Sheet Arrangements                                                      | 45
|Capital Expenditure Commitments                                                     | 45
|C. Research and development, patents and
    licenses, etc.                         | 46
|D. Trend Information                                                                | 46
|Litigation/Indemnification                                                          | 46
|Subsequent Events                                                                   | 47
|E. Off-balance sheet arrangements                                                   | 48
|F. Tabular disclosure of contractual obligations                                    | 48
|G. Safe harbor                                                                      | 48
|PART III                                                                            | 48
|Item 18. Financial Statements                                                       | 48
|Item 19. Exhibits                                                                   | 48
|Signatures                                                                          | 49

4

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EXPLANATORY NOTE REGARDING AMENDMENT NO. 1



We are filing this Amendment No. 1 on Form 20-F/A to amend Items 3, 4 and 5 of Part I, and Item 18 of Part III of the Annual Report on Form 20-F for the year ended December 31, 2006, as originally filed with the Securities and Exchange Commission (the SEC) on April 3, 2007 (the Original Filing). Amendment No. 1 is being filed for the purpose of revising certain information included in these Items as a result of a reclassification of our operating results to discontinued operations related to the sale of our minority interest in our e-Learning business segment.



In addition to amending the Items listed above, Item 19 of Part III of the Original Filing has been amended to add currently dated certifications from the Companys Chief Executive Officer and Chief Financial Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002. No other changes have been made to the Original Filing. This Amendment No. 1 does not reflect events occurring after the Original Filing or modify or update those disclosures affected by subsequent events.

PART I

Item 3. Key Information



A.

Selected financial data.



The following table summarizes certain of our selected financial information (stated in thousands of U.S. dollars) prepared in accordance with U.S. 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, 2006, 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 2002 and 2003, and the consolidated balance sheet information as of December 31, 2002, 2003, and 2004 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, 2002 throughout the fiscal year ended December 31, 2006.



|                                                        | 2006(4)                                              | 2005(4)     | 2004(4)     | 2003(4)  | 2002(4) 
|------------------------------------------------------- | ---------------------------------------------------- | ----------- | ----------- | -------- | --------
|                                                        |                                                      | Restated(3) | restated(3) |          |         
|                                                        | (in thousands of U.S. dollars except per share data)
|                                                        |                                                      |             |             |          |         
|Revenue from
    continuing operations                  | 11,836                                               | 10,614      | 12,899      | 9,919    | 6,481   
|Operating loss from
    continuing operations (1)       | (8,945)                                              | (4,120)     | (1,717)     | (1,544)  | (15,523)
|Operating loss from
    continuing operations per share | (0.19)                                               | (0.09)      | (0.04)      | (0.04)   | (0.33)  
|Net loss from
    continuing operations (1)             | (9,750)                                              | (4,489)     | (2,008)     | (2,146)  | (12,487)
|Net loss from
    continuing operations per share       | (0.21)                                               | (0.10)      | (0.05)      | (0.06)   | (0.33)  
|Net loss (2)                                            | (10,995)                                             | (5,317)     | (2,724)     | (2,931)  | (25,206)
|Basic and diluted net
    loss per share                | (0.24)                                               | (0.12)      | (0.07)      | (0.08)   | (0.67)  
|Total assets                                            | 14,547                                               | 22,405      | 21,699      | 10,686   | 11,870  
|Capital stock and
    additional paid-in capital        | 113,736                                              | 111,480     | 108,140     | 94,559   | 91,165  
|Accumulated deficit
    and accumulated other           |                                                      |             |             |          |         
|comprehensive loss                                      | (108,918)                                            | (98,158)    | (92,727)    | (90,278) | (87,510)
|Net assets                                              | 4,818                                                | 13,322      | 15,413      | 4,281    | 3,655   
|Outstanding shares, in thousands                        | 46,689                                               | 46,273      | 45,225      | 39,372   | 37,914  



(1) 2002 operating and net loss from continuing operations includes litigation and judgment 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).



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(3) Income tax expense for the year ended December 31, 2004, previously reported as nil, has been restated to $336,161. As a result, the net loss for the year ended December 31, 2004, previously reported as $2,388,199, has been restated to $2,724,360. Similarly, net loss per share for the year ended December 31, 2004, previously reported as $0.06, has been restated to $0.07. In addition, the accumulated deficit as at December 31, 2004, previously reported as $91,927,031, has been restated to $92,263,192. Comprehensive net loss for the year ended December 31, 2004, previously reported as $2,112,365, has been restated to $2,448,526.



(4)  On March 27, 2007, the Company sold its minority interest in its e-Learning business segment.  Because the Companys management had not previously been given a mandate by the Board of Directors to locate a purchaser of its investment in the e-Learning business segment, e-Learning was initially included in the Companys consolidated operating loss for all previous periods. As a result of the sale, for the years ended December 31, 2006, 2005, 2004, 2003, and 2002 the e-Learning operating results have been reclassified to discontinued operations.



Currency and Exchange Rates



The following table sets out the exchange rates for the U.S. dollar 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):



|                       | U.S. Dollar Per One Canadian Dollar
|---------------------- | -----------------------------------
|                       | Year Ended December 31             
|                       | 2006                               
|End of period          | 0.8581                             
|Average for the period | 0.8847                             



The following table sets out the high and low exchange rates for the U.S. dollar expressed in terms of one Canadian dollar in effect at the end of the following periods:



|                   | U.S. Dollar per One Canadian Dollar
|------------------ | -----------------------------------
|                   | December                           
|                   | 2006                               
|High for the month | 0.8795                             
|Low for the month  | 0.8581                             



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 June 8, 2007 as reported by the United States Federal Reserve Bank of New York for the conversion of United States dollar into Canadian dollars was U.S.$1.00 = CDN$1.0622.



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. 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.



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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 $11.0 million in our fiscal year ended December 31, 2006, $5.3 million in our fiscal year ended December 31, 2005, and $2.7 million in our fiscal year ended December 31, 2004. As of December 31, 2006, our accumulated deficit was $108.6 million. 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 due to future financings and our business may be restricted due to future borrowing arrangements.



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.



Our operations may have been, and could be in the future, adversely affected by the Receiver for the Lancer Funds holding approximately 40% of the Companys 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 the Receiver for the Lancer Funds who was appointed as a result of a U.S. Securities and Exchange Commission (the 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 believed their ownership amounted to approximately 49 percent of our outstanding shares at the time. As of December 31, 2006, the Lancer Funds have disclosed that their ownership amounted to approximately 40 percent 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. In July 2005, the Receiver for the Lancer Funds stated in a filing with the SEC that the Receiver was considering requesting a special meeting of shareholders for the purpose of removing the then current members of the Board of Directors (other than Donald Moore). In August 2005, the Receiver issued such a request and also a request for a copy of our shareholder list. In response to these actions, we obtained an interim order from the Court of Queens Bench of Alberta (the Alberta Court) prohibiting the Receiver from calling the special meeting, based upon the Lancer Funds apparent violations of applicable corporate and securities law. We also initiated proceedings before the Alberta Securities Commission (ASC) to require the Receiver to dispose of its shareholdings or make a proper takeover bid to all shareholders of the Company. The Receiver opposed these actions, and sought relief in a Florida court through a contempt motion against the Company. However, at the Companys annual general meeting of shareholders held on December 22, 2006, the Receiver voted in favor of our managements recommendation as to the composition of the Companys Board of Directors.



In February 2007, the Company and the Receiver entered into a conditional settlement agreement, which aims to settle any and all outstanding claims and issues between the Receiver, the Lancer Funds and the Corporation. See Item 4  Information on the Company  History and Development of the Company. According to the terms of the settlement agreement, both the Receiver and Michael Lobsinger, who are both significant shareholders of the Corporation, each have the obligation to vote their shares in favor of the other partys two director nominees, up until the Corporations shareholders meeting held in respect of the fiscal year ended 2007, and the Corporation shall not nominate Mr. Lobsinger nor certain persons or entities related to Mr. Lobsinger for appointment to the Corporations board of directors.



On April 10, 2007, a settlement agreement with the Receiver for the Lancer Entities became fully effective. Pursuant to the settlement agreement, the Receiver and the Company agreed to, among other things, immediately discontinue, with prejudice, all litigation and regulatory proceedings of any kind. In addition, the Receiver, the Company and certain current and former directors of the Company have agreed to deliver mutual releases. As a result of the settlement agreement, Michael E. Lobsinger has resigned as a director of the Company. He is replaced as a director by George Tai of Calgary, Alberta.



7

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The legal matters related to the Receiver have or may have adversely affected our operations in a number of ways:



•

The Company has incurred significant legal fees in connection with issues concerning the Receiver.

•

Promising acquisition candidates and possible financing sources have terminated discussions with us based upon uncertainty regarding the future composition of our Board of Directors and management of the Company and the possible impact of sales of our securities by the Receiver.

•

Our customers and potential customers have similarly raised concerns about the future management of the Company and our ability to live up to our contractual commitments.

•

Our efforts to recruit highly qualified members of executive management and additional directors from our industry have been hampered by the disputes between the Company and the Receiver.

•

Scarce management resources have been diverted from Company operations to addressing the foregoing concerns raised by our customers, employees, shareholders and potential acquisition candidates.



Uncertainties regarding the impact of possible sales of our shares by the Receiver may negatively impact the market price for our securities.



According to the Receivers filings with the SEC, as of the date of this Report, the Receiver holds approximately 40 percent of our outstanding shares. The Receiver has in the past, and may in the future, announce an intention to sell shares in the open market. These announcements, whether or not they are accompanied by contemporaneous sales, may have a depressive effect on the market price for our securities.



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;

•

evolving customer requirements; and

•

aggressive price competition.



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 and gain market share while controlling costs;

•

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:



8

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•

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.



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 we may not be able to compete successfully or gain market acceptance.



The software industry is intensely competitive and is characterized by rapid technological advances, evolving industry standards, price competition and technological obsolescence. 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; America Online Inc. (AOL); Nokia; OpenWave; Microsoft; Research in Motion,  Eatoni, Abaxia, Mobease, Communications Intelligence, PenReader, Vision Objects, TealPoint in Latin languages, PenPower, HanWang, Guobi and Chinastar. 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. 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.



Our products may contain defects that could harm our reputation, be costly to correct, expose us to litigation and harm our operating results and financial condition.



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. As well, defects and failures in our products could expose us to claims for liability or other claims involving costly litigation.



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.



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We rely on large and small customers to adopt our technology and our financial success may be affected if these customers 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 customers. Because the Zi Technology business segment relies heavily on third party integration of our technology into customer products, lead time to revenue recognition is longer than software products directly released into consumer channels. Purchase of our products by customers often requires significant expenditure of time and resources by the customers. 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 a technology provider for these customers, and the failure to be selected by our customers would have a material adverse effect on our sales. In addition, the resolution of a patent infringement claim with a principal competitor 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 customers to achieve market acceptance of products incorporating our software could have a material adverse effect on our business, operating results and financial condition.



As well, the Company has invested money, time and resources into the acquisition and development of Decuma and Qix technologies, both of which are recent additions to the Zi portfolio of products. We may not be successful in persuading customers to license such technologies. Potential customers may spend significant amounts of time evaluating our technologies prior to their decision to license and deploy our products. Furthermore, any customers who do license such technology may fail to achieve market acceptance of products incorporating such technologies. Due to our license-fee and royalty-based revenue models, any of the above-referenced potential failures 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. Customers 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 customers deciding to cancel or change their product plans. Our business would be adversely affected if a significant customer reduces or delays orders or chooses not to deploy products incorporating our technology.



Some of our major customers are not profitable and are subject to reduced demand for products and services currently affecting the telecommunications industry. In 2006, 2005 and 2004 we derived 34%, 31% and 34% 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 customers 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 customer licenses are at, or approaching, the end of their license terms and it is uncertain whether we will be successful in negotiating renewals with these customers.



Our overall market breadth for 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 customers with pre-packaged solutions; and

•

consolidation among the customer base.



10

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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 and educational institutions 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 or limit the ability of our customers to integrate our technologies onto their platforms. 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 made subject to claims of infringement, and, as described in the section below, we have been affected by such litigation. Even if we believe that we do not infringe, the costs of defending intellectual property litigation are substantial. 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.



For a summary of material legal proceedings related to the Company, see  Item 8  Financial Information  A. Consolidated Statements and Other Financial Information  Legal Proceedings.



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 AOL settled a judgment under 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 a consent judgment which prohibits the sale or use in the United States of earlier versions of the Companys eZiText product. Such earlier versions of eZiText 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, AOL and others seek to protect their intellectual property in various countries and jurisdictions through administrative proceedings and civil litigation. The settlement of the AOL 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 filed in respect of certain of AOL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.



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 strain 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.



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The Companys existing product portfolio is limited. Our financial success relies substantially on a 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 Milos Djokovic, President and Chief Executive Officer, Blair Mullin, Chief Financial Officer, Roland Williams, Senior Vice President of Technical Innovations, Axel Bernstorff, Vice President of Global Sales, Brandon Mensinga, Director  Qix and Corneil Goud, Director  Predictive Text, could have a materially adverse effect upon our ability to grow and operate profitably. The Companys insurance coverage does not include key-man life insurance for any of the above mentioned individuals. It should be noted that we have engaged an executive services and consulting firm to provide us with the services of Blair Mullin as our Chief Financial Officer.



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.



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 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.



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We may require capital to finance the continued growth of operations. To date, we have raised capital primarily through private placements of common shares. As of March 23, 2007, our cash position was approximately $2.30 million. Subsequent to March 23, 2007, the Company announced that it had secured commitments totaling $6,000,712 in gross proceeds from individual and institutional investors in a brokered private placement in the United States and a non-brokered private placement in Canada.  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.



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 and other litigation the Company is involved in.



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 products 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.



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The laws and policies restricting foreign alliances, partnerships, investments, distribution or sale in the 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 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.



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 U.S. 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.



At December 31, 2006, the Company held the U.S. dollar equivalent of $2,160,495 (December 31, 2005 - $648,119) in Chinese renminbis (RMB) through its principal Chinese subsidiary.  Due to PRC government regulations pertaining to the capitalization of Chinese companies, these funds are not expected to be fully available to fund the non-Chinese operations of the Company in the foreseeable future.



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. dollar, principally the Canadian dollar, Hong Kong dollar, Chinese renminbi and Swedish krona. Our results are reported in U.S. dollars. Accordingly, fluctuations in exchange rates have a material effect on our results of operations. In 2005, Chinese authorities re-valued the renminbi and it is no longer pegged against the U.S. dollar. 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 $235,113, a loss of $114,108 and a gain of $275,834 in each of 2006, 2005 and 2004, 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;



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the difficulty and expense of integrating the operations and personnel of the target companies, especially where the target company 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

•

the incurrence of amortization expenses; and

•

possible dilution to our shareholders.



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.



As a non-U.S. corporation, it may be difficult for shareholders to pursue claims under U.S. 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 judgments of courts of the United States predicated upon civil liabilities under the federal securities laws of the United States.



We are subject to examinations by taxation authorities of the jurisdictions in which we operate in the normal course of operations.



In 2006, Canada Revenue Agency (CRA) commenced an audit of Zi Corporation. We intend to present to CRA a comprehensive review of our international transfer pricing policies and procedures and documentation requirements. The ultimate resolution of this matter is uncertain and we are currently working with our tax advisors to determine a range of possible outcomes.  Should the ultimate resolution be unfavourable for the Company, we could be faced with a significant tax liability.



The Company may lose its foreign private issuer status in the future, which could result in significant additional costs and expenses to the Company.



In order to maintain the Companys current status as a foreign private issuer, as such term is defined in Rule 405 under the U.S. Securities Act of 1933, as amended, for U.S. securities law purposes, the Company must not have any of the following: (i) a majority of its executive officers or directors are U.S. citizens or residents, (ii) more than 50% of its assets are located in the U.S., or (iii) the business of the Company is principally administered in the U.S.  The Company may in the future lose its foreign private issuer status if it fails to meet any of the aforementioned criteria.



The regulatory and compliance costs to the Company under U.S. securities laws as a U.S. domestic issuer may be significantly more than the costs the Company incurs as a Canadian foreign private issuer eligible to use the Multi-Jurisdictional Disclosure System (MJDS). If the Company is not a foreign private issuer, it would not be eligible to use the MJDS or other foreign issuer forms and would be required to file periodic and current reports and registration statements on U.S. domestic issuer forms with the U.S. Securities and Exchange Commission, which are more detailed and extensive than the forms available to a foreign private issuer. In addition, the Company may lose the ability to rely upon exemptions from NASDAQ corporate governance requirements that are available to foreign private issuers. Further, if the Company engages in capital raising activities after losing its foreign private issuer status, there is a higher likelihood that investors may require the Company to file resale registration statements with the SEC as a condition to any such financing.



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If the Company is characterized as a passive foreign investment company, its shareholders may be subject to adverse U.S. federal income tax consequences.



The Company has not made a determination as to whether it is considered a passive foreign investment company (a PFIC), as such term is defined in the U.S. Internal Revenue Code of 1986, as amended (the Code), for U.S. federal income tax purposes for the current tax year and any prior tax years. A non-U.S. corporation generally will be considered a PFIC for any taxable year if either (1) at least 75% of its gross income is passive income or (2) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income.



In general, if the Company is or becomes a PFIC, any gain recognized on the sale of securities and any excess distributions (as specifically defined in the Code) paid on the securities must be ratably allocated to each day in a U.S. taxpayers holding period for the securities. The amount of any such gain or excess distribution allocated to prior years of such U.S. taxpayers holding period for the securities generally will be subject to U.S. federal income tax at the highest tax applicable to ordinary income in each such prior year, and the U.S. taxpayer will be required to pay interest on the resulting tax liability for each such prior year, calculated as if such tax liability had been due in each such prior year.  See Item 10.E - Material United States Federal Income Tax Consequences.



The Company may be deemed to be a controlled foreign corporation under the Code.



If more than 50% of the voting power of all classes of shares or total value of the shares of the Company is owned, directly or indirectly, by citizens or residents of the United States, United States domestic partnerships and corporations or estates or trusts other than foreign estates or trusts, each of whom owns 10% or more of the total combined voting power of all classes of shares of the Company, the Company could be treated as a controlled foreign corporation, as such term is defined under Subpart F of the Code.  This classification would effect many complex results including the required inclusion by such United States shareholders in income of their pro rata shares of Subpart F income (as specifically defined by the Code) of the Company.



The Company has not made a determination as to whether it is a controlled foreign corporation under the Code, and cannot give any assurance that it would not be determined to be a controlled foreign corporation under the Code now or in the future.  See Item 10.E - Material United States Federal Income Tax Consequences.



Item 4-Information on the Company



A. History and Development of the Company



Our head and principal office is located at Suite 2100, 840 - 7th 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 Global Market under the symbol ZICA.



We were incorporated under the Business Corporations Act (Alberta) in Alberta, Canada on December 4, 1987 as Cancom Ventures Inc. On August 30, 1989, 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. 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.



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From March 1997 to February 1998, we provided Internet web development services in conjunction with carrying on our present business.



Acquisition and Development of Input Technology



Effective November 1993, we acquired three licenses relating to certain computer software, word processing software and language translation technology known as the Jiejing Input System, the Zitong Input System and the Chappell/Yates Translation Technology, respectively (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.



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 forcomposing the characters are classified into different groups, each identified by a code number. The string of code numbers representing each character follows 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, Europe and Asia based on ideographic language input networks and software utilities which use text as a key part of their operation.



The following is a partial list of certain U.S. patents which have been issued to the Company, which further strengthen our competitive position: U.S. patent No. 6,956,968 - Database Engines for Processing Ideographic Characters and Methods Therefor; U.S. patent No. 6,955,602 - Text Entry Within a Video Game; U.S. patent No. 6,864,809 - Korean Language Predictive Mechanism for Text Entry By a User; and U.S. patent No. 6,801,659 - Text Input System for Ideographic and Non-Ideographic Languages.



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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 was designed to increase the speed of input and allow inexperienced users to approach the desired character more quickly without having to search a long list of candidates. The Company believes that this approach is much simpler than full handwriting recognition and is compatible with low resource computing environments typical of the cellular telephone market.



Acquisition and Divestiture 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.



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.



On July 31, 2001, the Company caused one of its subsidiaries, namely Asia Translation & Telecommunications Limited (AT&T), 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 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. The Option expired, unexercised.



Effective as of December 2005, Archer Education Group Inc. acquired Oztime from AT&T, with the purchase price set at 4,800,000 common voting shares of Archer, of which 4,140,000 shares were issued in the name of AT&T, and 660,000 shares were issued in the name of certain Oztime employees, as designated by AT&T. Of the 4,140,000 shares issued to AT&T, 1,000,000 shares were deposited with an escrow agent (the Archer Escrow Shares). The release of the escrowed shares was subject to performance criteria requiring revenues earned through Oztime related operations, from the date of purchase to December 31, 2006, be $2,950,000 or more. The Company determined there was uncertainty that Oztimes revenues related to its operations would achieve the performance criteria and as such the contingent consideration was not considered as part of the sale proceeds.   As at December 31, 2006, Oztime revenues earned did not reach the required level and therefore the escrowed shares were cancelled.



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As of December 31, 2005 approximately 53.2 percent of Archers outstanding shares were owned by Zi or its subsidiaries. As of December 31, 2006, the Companys ownership position in Archer had been diluted to 42.2 percent.  Subsequent to March 23, 2007, Zi announced the sale of all Archer shares held by it, for CDN$736,800 in cash, or approximately US$632,601.



Acquisition and Divestiture 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 did not prove to be effective and revenue streams did not develop following the acquisition. We did not believe that EPI would contribute any material revenues to us in the future as a standalone entity. As a result, EPI content and software products were integrated into Oztimes education portal business.



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 were 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 was integrated into Oztimes business plan. See Item 4 - Information on the Company - B. Business Overview.



Effective as of December 2005, Archer acquired from Zi all of the outstanding shares of EPI, with the purchase price being set at 2,000,000 common voting shares of Archer.



As of December 31, 2005 approximately 53.2 percent of Archers outstanding shares were owned by Zi or its subsidiaries. As of December 31, 2006, the Companys ownership position in Archer had been diluted to 42.2 percent. Subsequent to March 23, 2007, Zi announced the sale of all Archer shares held by it, for CDN$736,800 in cash, or approximately
US$632,601.



Acquisition of Archer Education Group Inc.

Archer was incorporated in February 2005 for the purpose of acquiring a number of educational learning institutions in Canada. Zi acquired 24.9 percent of Archers shares, through share subscription agreements in 2005. Consequently, Zi became a related party to Archer.



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The Companys ownership of Archer increased primarily by the sale of its Beijing Oztime Education & Network Technology Co. Ltd. (Oztime) and EnglishPractice Inc. (EPI) subsidiaries to Archer.  At December 31, 2005, the Company held 53.2 percent of the outstanding shares of Archer. Zi therefore, accounted for its investment in Archer as a purchase under the purchase method of accounting. Zi included Archers results from December 21, 2005 (the date of acquisition) to December 31, 2005, and its assets and liabilities, net of minority interest at December 31, 2005.



Under the sale agreements, Zi received 6,140,000 shares of Archer, including contingent consideration of 1,000,000 shares placed in escrow and a RMB 1,000,000 note receivable. The release of the escrowed shares was subject to performance criteria requiring revenues earned through Oztime related operations, from the date of purchase to December 31, 2006, be $2,950,000 or more. The Company determined there was uncertainty that Oztimes revenues related to its operations would achieve the performance criteria and as such the contingent consideration was not considered as part of the sale proceeds.   As at December 31, 2006, Oztime revenues earned did not reach the required level and therefore the escrowed shares were cancelled.



On February 28, 2006, Archer raised additional capital through private placements of common shares at which point Zis interest in Archer was diluted to 49.9 percent. The Company has deconsolidated the results of Archer as of March 1, 2006, since it no longer absorbs a majority of the entities expected losses or residual returns, in the case of a variable interest entity, and no longer has the ability to exert control over this subsidiary. The Company has accounted for its proportionate share of Archers net loss at December 31, 2006, using the equity method.



Through a further private placement of Archers common shares and exercise of stock options from March to December 2006, the Companys ownership of Archer was diluted to 42.2 percent. As the price of the shares issued by Archer is in excess of the book value of the underlying share, the Companys net investment in Archer increases resulting in a dilution gain to Zi of $758,903 as of December 31, 2006.



Subsequent to March 23, 2007, Zi announced the sale of all Archer shares held by it, for CDN$736,800 in cash, or approximately US$632,601. The book value of the Archer shares sold had previously been reduced to zero by Zi; therefore, the Company has recorded a gain on the sale in the first quarter of 2007 of US$632,601.



Acquisition of Assets of Decuma AB



On January 26, 2005, Zi Decuma AB, a company incorporated under the laws of Sweden and a wholly owned subsidiary of the Company, acquired substantially all of the assets of handwriting recognition software specialists Decuma AB of Lund, Sweden. As part of the acquisition, the Company acquired certain intellectual property and customer agreements of privately held Decuma AB, as well as assuming certain liabilities of Decuma AB. As part of such acquisition, Zi Decuma AB offered employment to each employee of Decuma AB, on the terms and conditions equal to their employment terms and conditions with Decuma AB. The purchase price was approximately U.S.$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).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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As a part of the proceedings, on February 21, 2002, the District Court granted a summary judgment 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.



On September 4, 2002, the jury in this lawsuit found that certain versions earlier than version 4.5 of the Companys eZiText product (the U.S. Restricted Versions) infringed Tegics U.S. 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 U.S. patents and to set aside the Damages Award.



The Company settled all claims in this lawsuit with AOL by a written settlement agreement dated December 6, 2002. As part of the settlement, a Consent Judgement was entered on December 20, 2002. The settlement in relation to the U.S. 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 current 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 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), a Hong Kong based 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s activities were integrated into our wholly-owned subsidiary, Zi Corporation (H.K.) Limited. As part of this integration, the various business lines of Zi Services (a former business unit of the Company) were narrowed to focus specifically on developing Bluetooth and VoIP technologies.



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 for proceeds of $220,000.



The Magic Lantern Group of Companies



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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 senior management 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 Lantern Group were retained at that time.



On November 7, 2002, the Company completed the sale of 55 percent of its interest in the Lantern Group to JKC Group Inc., which at the time 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 traded on the AMEX under the ticker symbol GML. At closing, the Company received a 45 percent 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 was registered with the SEC 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 was reduced to $2,000,000.



Subsequent to the closing, the Company learned that MLGs then-controlling shareholder, an affiliate of Michael Lauer and several funds known as the Lancer Group, had acquired and owned on an undisclosed basis, what was subsequently disclosed to be a 49.3 percent interest in Zi at that time. See: Item 4  Information on the Company  A. History and Development of the Company  Acquisition of Zi Shares by the Lancer Funds. 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, in particular, the failure of MLG to make scheduled interest payments on its indebtedness to Zi.



We have written off the carrying value of our investment in MLG.  In February 2006, we received notice that MLG had ceased operations in 2005 and has commenced a voluntarily liquidation and wind down. The Company does not expect to realize any recovery from its investment in MLG.



Archer Education Group Inc.



See: Item 4 - History and Development of the Company - Acquisition of Archer Education Group Inc. above.



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 of 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 totaling 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. Through its attorneys, Management requested 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.



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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 Lancer Funds' holdings. The Receiver remained uncertain of the Lancer 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 SEC or other appropriate agencies. The Company offered assistance to the Receiver to determine the extent of the Lancer Funds holdings in the Company, including the provision of copies of its registered shareholder records and private placement subscription details.



In 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, as amended (the Securities Act) the Receiver is deemed to be an affiliate (as such term is defined in Rule 405 of the Securities Act) 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.



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 Securities Act. According to amendments to Schedule 13D, the Receiver sold an aggregate 689,356 shares of Zi during January and February 2005. On February 10, 2005, the Receiver filed Form 45-102F1 in Canada stating its proposal to sell 2,875,132 shares of Zi. On March 11, 2005, the Receiver filed Form 45-102F1 in Canada stating its proposal to sell 2,674,040 shares of Zi. No shares were sold in March 2005. On April 8, 2005, the Receiver filed Form 45-102F1 in Canada stating its proposal to sell up to 2,674,040 shares of Zi.  On April 18, 2005 the Receiver filed an intention to sell in the aggregate up to 2,674,040 common shares in the ninety days thereafter pursuant to Rule 144. No shares were sold in April 2005. On May 6, 2005, the Receiver filed Form 45-102F1 in Canada stating its proposal to sell up to 2,674,040 shares of Zi. Notwithstanding the Receivers filings concerning the possible sale of shares of Zi, to the best of the Companys knowledge, no shares have been sold by the Receiver since February 2005. According to the Receivers filings with the SEC, as of the date of this Report, the Receiver holds approximately 37 percent of our outstanding shares.



In July 2004, Zi completed a private placement for gross proceeds of CDN$10 million. As a condition of the financing, the Receiver, among others, agreed to a 150 day lock up of its shares. In return for this consideration, the Company agreed, among other things, to appoint one director to the Companys board as a nominee of the Receiver.  The Company subsequently appointed Donald Moore to the Board of Directors as the Receivers nominee.



In 2005, the Receiver contacted the Company to request certain shareholder information with a view to calling a special meeting of the Companys shareholders, the purpose of which would be to elect a slate of directors proposed by the Receiver.



The Company sought the advice of legal counsel and concluded, among other things, that it would not cooperate with the Receiver in effecting what the Company believed was an unlawful takeover of the Company. In its filings to the Alberta Court, the Company cited Lancers failure to comply with Alberta laws regarding takeover bids. The Alberta Court issued an interim order that, among other things, prohibited the Receiver from requisitioning a shareholders meeting. The Receiver brought a motion to contest the Alberta Courts jurisdiction and to seek to have all related matters dealt with in a Florida Court. The Alberta Court, in a decision dated January 31, 2006, denied the Receivers application to change venue, citing the Alberta Court as the proper forum to consider matters under theBusiness Corporations Act (Alberta) (ABCA) and the Securities Act (Alberta)and refused to set aside its interim order against the Receiver.



The Company brought a companion proceeding before the ASC on December 5, 2005, seeking among other things an order requiring the Receiver to either dispose of the Lancer Funds' Zi shares or make a lawful takeover bid to all of Zi's shareholders.  On March 16, 2006, the ASC dismissed a motion by the Receiver to stay or dismiss the ASC proceedings.



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Separately, the Receiver instituted a contempt of court hearing before the U.S. District Court for the Southern District of Florida (the Florida Court) claiming that the Companys filing before the Alberta Court violated a case management order which mandated that all proceedings against the Receiver be brought in the Florida Court. The Company was not a party to any previous proceeding before the Florida Court and argued that it was not subject to the case management order.



Zi had previously agreed to a U.S. venue for resolving certain contractual issues with the Receiver and the Alberta Court acknowledged that such agreement does not affect the Alberta Courts ability to rule on matters under the ABCA and Alberta securities laws.



At the Companys annual general meeting of shareholders held on December 22, 2006, the Receiver voted in favor of our managements recommendation as to the composition of the Companys Board of Directors. In February 2007, the Company and the Receiver entered into a settlement agreement, which aims to settle any and all outstanding claims and issues between the Receiver, the Lancer Funds and the Corporation. The settlement is conditioned upon the Receiver securing orders from the United States District Court for the Southern District of Florida and the United States Bankruptcy Court for the Southern District of Florida, authorizing the Receiver to execute the settlement agreement on behalf of the Lancer Funds. The settlement is also conditioned upon the parties securing the acknowledgement of the ASC that the ASC will dismiss with prejudice Zi's pending action against the Receiver; that the ASC has no objection to the parties terminating such pending action; and that the ASC will take no further action based on acts of Michael Lauer and others which preceded the Receivers appointment, and such acknowledgement is not expected to be contentious. To date, orders have been secured from the United States District Court for the Southern District of Florida and from the United States Bankruptcy Court for the Southern District of Florida. The date of receipt of all such orders and acknowledgement will be the effective date of the settlement agreement (the "Settlement Agreement Effective Date"), which shall not be later than 120 days following the execution of the settlement agreement. Pursuant to the settlement agreement, as at the Settlement Agreement Effective Date, the Receiver and the Corporation have agreed to immediately discontinue, with prejudice, all litigation and regulatory proceedings of any kind.



In February 2006, Donald Moore, a director of the Company nominated by the Receiver, brought an action against the Company and Michael Lobsinger, who was the Chairman, President and CEO of the Company at such time, under the ABCA, claiming that the Corporation had failed to make certain records available to him as required by the ABCA and had denied him access to other records that he believed to be entitled to under the ABCA. This matter has been settled between the parties.



Principal Capital Expenditures and Divestiture



During the years ended December 31, 2003, 2004, 2005, 2006, and up to February 28, 2007 our principal capital expenditures were as follows:

|                                 | Amount of Expenditure (Divestiture)
|-------------------------------- | -----------------------------------
|                                 |                                    
|                                 |                                    
|Description of Expenditure       |                                    
|Capitalized Software Development |                                    
|Costs                            | $                                  
|Acquisition of Archer            |                                    
|Acquisition of Decuma            |                                    
|Acquisition of Magic Lantern     |                                    
|Computer & office equipment      | $                                  



During the years ended December 31, 2003, 2004, 2005, 2006 and up to March 23, 2007, the Company did not have any significant capital divestitures.



In January 2005, the Company acquired the assets of Decuma AB for approximately U.S.$1.0 million, including fees and expenses. In the remainder of 2007, the Companys planned principal capital expenditures will be software development costs. The Company expects these expenditures will be incurred primarily in Canada, China and Sweden. See Item 18 - Financial Statements - Note 4 for a detailed description of the acquisitions. These planned capital expenditures will be financed through existing cash reserves.



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Financing efforts subsequent to 2006 year end.



In March 2007, the Company announced that it had secured commitments totaling $6,000,712 in gross proceeds from individual and institutional investors in a brokered private placement in the United States and a non-brokered private placement in Canada. The private placements will result in the issuance of 3,776,848 units ("Units"), with each unit comprised of one common share and 40 percent of one common share purchase warrant, at a price of US$1.61 per Unit. The Warrants have a term of five years and can be exercised commencing six months from the date of closing. Each Warrant has an exercise price per common share of US$2.14. Proceeds are intended to be used for general corporate purposes.



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, eZiType, Decuma and Qix business is carried on. Our core technology product, eZiText, and its companion application, eZiType, are predictive text input solutions that predict words and/or phrases for use in messaging and other text applications. eZiText supports 60 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, which is a mobile search and service discovery engine that enables rapid discovery of contacts, features, services and more, on mobile handsets. Qix
removes barriers to revenue-producing features on mobile phones by significantly
reducing the number of key presses needed to navigate through content.



Zi Technology Business Unit



Description of eZiText and eZiType



Although eZiText can be used in 60 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.



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 stroke 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 Chinese words consist of more than one character) and even phrase completion.



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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 alphabetic 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.



In 2006, Zi announced its development of a predictive text solution for keyboards called eZiType. This solution offers the predictive word capabilities similar to eZiText, with the added benefit of auto-correction when users misspell or accidentally press the wrong character. The solution is made for physical and virtual keyboards and currently applies to alphabetic based languages.



eZiText can now be used in the following languages: Afrikaans, Arabic, Bengali, Bulgarian, Chinese (PRC, Hong Kong and Taiwan), Croatian, Czech, Danish, Dutch, English (British, American PRC, Hong Kong and Taiwan), Estonian, Farsi, Finnish, French (European and Canadian), German, Greek, Gujarati, Hebrew, Hindi, Hungarian, Icelandic, Indonesian, Italian, Japanese, Kannada, Korean, Latvian, Lithuanian, Malay, Marathi, Malayalam, Norwegian, Polish, Portuguese (European and Brazilian), Punjabi, Romanian, Russian, Serbian, Slovak, Slovenian, Spanish (European and Latin American), Swahili, Swedish, Tagalog, Tamil, Telugu, Thai, Turkish, Ukrainian, Urdu and Vietnamese.



eZiText also includes a predictive multi-tap mode (formerly offered as part of a separate product called eZiTap), wherein each character is deterministically established by the user by tapping the keys, rather than having the particular characters predicted for the user.



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 and eZiType technology are distributed through licensing agreements.



From time to time, Zi releases new versions of eZiText and eZiType 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.



Moreover, Zi has 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 the Microsoft Windows Mobile platform and Front End Processors (FEPs) for Symbian S60 smart phones for eZiText and eZiType. These solutions enable OEMs easy access to Zis core products on leading smart phone platforms.



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In 2002, Zi announced its initial development of a network-based platform that enables the integration of wireless communication devices with the network called eZiNet.



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 Qix and 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, 2007, Zi has entered into licenses with more than 100 licensees who are in many cases original equipment manufacturers that embed eZiText into their respective products. These licensees include among others, cellular phone manufacturers, set-top box manufacturers and game manufacturers.



To the best of our knowledge, approximately 88 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 2006, 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. The royalty amount varies from customer to customer and may vary 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, 2006, two customers accounted for 34 percent of our total revenue.



Description of Qix



In February 2005 at the annual 3GSM conference, 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.

At the 2007 3GSM conference, Zi announced the release of Qix for two platforms; S60 and Windows Mobile. Qix for S60 is available for operator deployment supporting the latest phones available in the market that use the S60 3rd Edition platform. The Symbian OS S60 platform is a leading smartphone platform, offered on millions of devices and supporting thousands of available mobile applications on the market. Qix for Windows Mobile 5 is also available for operator deployment. It is expected that 30 million Windows Mobile Smartphones will ship in 2007 around the globe based on published figures by RBC Capital Markets on Microsoft. Zi expects to extend support to Windows Mobile 6 by the end of 2007.



The first market trial and deployments of Qix occurred with Virgin Mobile and T-Mobile (UK) Limited (T-Mobile). The results from the Virgin trial indicated a sustained 33% increase in average revenue per user (ARPU) in use of voice calls, SMS, MMS, and internet data services during the trial period. T-Mobile is expected to deploy 25,000 Nokia S60 units as part of their deployment. T-Mobile is initially offering Qix in the UK, and the global agreement with Zi Corporation provides for possible additional rollouts in other countries covered by T-Mobile.



Description of Decuma Handwriting Recognition Solutions



In January 2005, we acquired the assets of Decuma AB of Lund, Sweden. Decumas handwriting recognition solutions include Decuma Alphabetic, Decuma Japanese, Decuma Chinese, Decuma Korean and Decuma Arabic, which together comprise more that 70 languages and dialects.



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Decuma is designed for mobility, to work optimally on small form factor devices such as mobile phones, portable gaming consoles and more - on devices that are prone to poor and shaky handwriting. There is no need to adjust to a particular writing style, learn a special alphabet, or manually switch between character sets or input modes. Decuma has the capability to predict whole words as a user is writing each letter.



Decuma Alphabetic recognizes naturally shaped letters in upper and lower cases, numbers and symbols/punctuation. This includes 60 plus Latin, Greek and Cyrillic based languages.



Decuma Arabic supports naturally shaped Arabic, Farsi and Urdu letters, Arabic-Indic numbers and punctuation/symbols, recognizing the natural variations commonly found in Arabic writing styles, for all markets. The solution offers a consistent user experience found on an Arabic keyboard or keypad. It also provides full regional support including support for English, French, digits and punctuation/symbols.



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.



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 February of 2006, the Company announced the fusion of the Decuma Handwriting Recognition technology and predictive text. This combines the word prediction capabilities of eZiText in conjunction with handwriting recognition.



Investment in Archer Education Group Inc.



As of December 31, 2006, the Company was a 42.2 percent owner of Archer Education Group Inc., an international education company. Subsequent to March 23, 2007, Zi announced the sale of all Archer shares held by it, for CDN$736,800 in cash, or approximately US$632,601.



Through a combination of electronically delivered instruction, the interactive nature of the Inter/Intranet, and traditional classroom bricks and mortar learning, Archer Education Group intends to provide a blended form of personal and organizational teaching and learning to those parts of the world where there is greatest need and demand for education and training.



Archer Education and Oztime currently consist of online learning, and five bricks and mortar schools.



Capitalizing on the synergies between the bricks and mortar schools and Oztime, Archer Education Group believes it has the capabilities to: develop and localize  course content; deliver via the Internet already developed courseware for students from kindergarten through to the twelfth grade; provide blended, customized leadership and management training to the corporate world and governments, delivered both within the classroom and via corporate Intranets; offer ESL to corporate, government, and educational clients; and sell or license its Learning Management System, which consists of sophisticated software that automates the learning process via the Internet (course delivery, discussion groups, administrative tasks, testing).



Oztime sells and supports two suites of products:

•

Enterprise software used by corporations and academic institutions for tracking and managing e-Learning (Learning Management System); and

•

Courseware in both customized and standard format.



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Customized courseware is the building of e-Learning courses that have been adapted from a clients existing training material (usually offline). Standard courseware is e-Learning courses that have been built for a general audience and cover a subject area with a strong demand that is not or cannot be met by traditional classrooms, such as ESL.



Geographic Segments



The table below summarizes the Companys revenues by activity and geographic market for the last three fiscal years:

|     |  |  |            |  |  |  |  | License and implementation fees
|---- |  |  | ---------- |  |  |  |  | -------------------------------
|2006 |  |  | Canada(1)  |  |  |  |  |                                
|     |  |  | China(2)   |  |  |  |  |                                
|     |  |  | USA(3)     |  |  |  |  |                                
|     |  |  | Sweden(4 ) |  |  |  |  |                                
|     |  |  | Total      |  |  |  |  |                                
|2005 |  |  | Canada(1)  |  |  |  |  |                                
|     |  |  | China(2)   |  |  |  |  |                                
|     |  |  | USA(3)     |  |  |  |  |                                
|     |  |  | Sweden(4)  |  |  |  |  |                                
|     |  |  | Total      |  |  |  |  |                                
|2004 |  |  | Canada(1)  |  |  |  |  |                                
|     |  |  | China(2)   |  |  |  |  |                                
|     |  |  | USA(3)     |  |  |  |  |                                
|     |  |  | Total      |  |  |  |  |                                

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 Huayu Zi Software Technology (Beijing) Co. Ltd and Zi Corporation (H.K.) Limited are in Asia.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(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.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | The actual geographic markets for products licensed under licensing agreements between OEMs and Zi Decuma AB are in Asia, Europe and the United States.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------



C. Organizational Structure



Unless otherwise indicated, Zi, or one or more of its subsidiaries, owns 100 percent of the outstanding shares of the subsidiary.



|Name of Subsidiary                                  | Country of Incorporation
|--------------------------------------------------- | ------------------------
|Multi-Corp International Ltd.                       | Barbados                
|Zi (Bermuda) Corporation Ltd.                       | Bermuda                 
|Zi Oztime Corporation Ltd.                          | Bermuda                 
|Zi Technology Corporation Ltd.                      | Bermuda                 
|845162 Alberta Ltd.                                 | Canada                  
|Archer Education Group, Inc.(4)                     | Canada                  
|Zi Corporation of Canada, Inc.                      | Canada                  
|Huayu Zi Software Technology (Beijing) Co., Ltd.(2) | China                   
|Zi Software Technology (Beijing) Co., Ltd.          | China                   
|Asia Translation & Telecommunications Limited       | Hong Kong               
|Huayu Zi Software Technology Limited.(1)            | Hong Kong               
|Telecom Technology Corporation Limited              | Hong Kong               
|Zi Corporation (H.K.) Limited                       | Hong Kong               
|Zi Decuma AB                                        | Sweden                  
|Magic Lantern Group, Inc.(3)                        | USA                     
|Zi Corporation of America, Inc.                     | USA                     



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Notes:

|(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 percent (40%) of Magic Lantern Group, Inc.                                                                                                                                                                                                                                                
|(4) | As of December 31, 2006, Asia Translation and Telecommunications Limited held twenty-one point six percent (21.6%) of Archer Education Group Inc. and Zi Corporation held twenty point six percent (20.6%) of Archer Education Group Inc. Subsequent to March 23, 2007, all such holdings were sold to a third party.



D. Property, plants 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 square
footage
|-------------------- |  | ------------------------------------------------------- |  | -------------------------------- |  | --------------------------
|Calgary, Alberta     |  | Corporate head office and engineering office            |  | Lease expires June 30, 2012      |  | 13,355 sq ft              
|Martinez, California |  | North American sales office                             |  | Lease expires  November 30, 2007 |  | 350 sq ft                 
|Hong Kong, SAR       |  | Asia Pacific sales and engineering office               |  | Lease expires  November 30, 2007 |  | 225sq ft                  
|Beijing, PRC (ZST)   |  | PRC R&D office                                          |  | Lease expires February 28, 2008  |  | 3,606 sq ft               
|Beijing, PRC (ZiB)   |  | PRC sales and engineering office                        |  | Lease expires December 31, 2007  |  | 4,252 sq ft               
|Lund, Sweden         |  | Corporate head office and engineering office for Decuma |  | Lease expires June 30, 2008      |  | 4,237 sq ft               



We believe our facilities are adequate for our operations and have no plans to add facilities during the remainder of 2007.



Item 5. Operating and Financial Review and Prospects



The following table summarizes certain of our selected financial information (stated in thousands of U.S. dollars) prepared in accordance with U.S. GAAP. The information in the table was derived from the more detailed financial statements for the fiscal year ended December 31, 2004 through the fiscal year ended December 31, 2006, 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.



|For the years ended
    December 31 (thousands except per share amounts) |   | 2006     |   | 2005    |   | 2004    
|------------------------------------------------------------------------ | - | -------- | - | ------- | - | --------
|                                                                         |   |          |   |         |   | restated
|Revenue                                                                  | $ | 11,836   | $ | 10,614  | $ | 12,898  
|                                                                         |   |          |   |         |   |         
|Gross margin                                                             | $ | 11,430   | $ | 10,258  | $ | 12,536  
|                                                                         |   |          |   |         |   |         
|Net loss                                                                 | $ | (10,995) | $ | (5,317) | $ | (2,724) 
|                                                                         |   |          |   |         |   |         
|Total assets                                                             | $ | 14,547   | $ | 22,405  | $ | 21,699  
|                                                                         |   |          |   |         |   |         
|Net loss per share -
    basic and diluted                               | $ | (0.24)   | $ | (0.12)  | $ | (0.07)  
|                                                                         |   |          |   |         |   |         
|Outstanding shares,
    weighted average                                 |   | 46,503   |   | 46,153  |   | 41,373  
|                                                                         |   |          |   |         |   |         
|Outstanding shares,
    end of year                                      |   | 46,689   |   | 46,273  |   | 45,225  
|                                                                         |   |          |   |         |   |         

30

The above table has been reclassified to reflect the results from continuing operations.



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A.

Operating results.



All dollar amounts are in U.S. dollars and in conformity with U.S. GAAP. This information should be read in conjunction with the Companys audited financial statements and notes, which have been included elsewhere in this annual report.



Zi is incorporated under the Business Corporations Act (Alberta).



Zi makes software that simplifies data entry and interaction on communication devices. Zi provides easy and intuitive interface products that open the door to a phones full functionality, inspiring the user to explore and enjoy all the features and services the phone has to offer.



Zi’s full range of intuitive and easy-to-use solutions include  eZiTypeTM predictive keyboard with auto-correction, eZiText for one-touch predictive text entry, eZiTap for intelligent multi-tap entry, Decuma for natural handwriting including prediction technology, and Qix, a revolutionary search and discovery engine designed to enhance the user experience and drive client and network service usage and adoption.  Zis product portfolio now includes 60 language databases, representing languages spoken and written by two-thirds of the world's population.



With an expanded portfolio of products, Zi has a singular focus to make mobile devices smarter and easier to use with software products that simplify data entry and interaction on a communications device.



Zis primary customers are original equipment manufacturers (OEMs) and original design manufacturers (ODMs) seeking to embed a text input solution in their device products for consumer use.  Zis customer and alliance base is extensive and continually growing with handset manufacturing and gaming console customers from around the world, including: Nokia, Sony, Sony Computer Entertainment, Sony Ericsson, Nintendo, Motorola, LG Electronics, ZTE, Lenovo, UT Starcom and Kyocera.  Currently, eZiText has been introduced to consumers worldwide on more than 1,000 unique mobile devices.



Zi believes it has positioned itself to take advantage of the evolution of messaging and is committed to expanding the reach of its technologies and developing innovative product additions and enhancements to meet this usability challenge.



In 2005, Zi strategically expanded its suite of innovative products through acquiring Decuma handwriting recognition technology and launching its Qix search and discovery engine into carrier trials.  Zi believes both will further assist in increasing its competitive advantage and market share.  The use of handwriting as an interface on a mobile device, such as a PDA or mobile phone, is becoming increasingly important with the evolution to 3G multimedia applications and services.



Qix takes a predictive approach to navigation making it easier for consumers to use advanced services, thus driving service usage and adoption  ultimately, resulting in increased average revenue per user (ARPU) for wireless carriers.  In June 2006, a trial with UK operator Virgin Mobile demonstrated a 33 percent increase in ARPU among consumers in the trial.  This data, along with data from similar trials, is used to market this technology to wireless carriers.  In the fourth quarter 2006, Zi announced its first revenue generating agreement for Qix with T-Mobile (UK) Limited (T-Mobile), a major global wireless service operator.



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Recent Developments:



There were several changes to management in 2006, including appointment of a new President & Chief Executive Officer, Chief Financial Officer, Vice President Global Sales, and Corporate Controller. Milos Djokovic, was promoted to President & Chief Executive Officer from his previous position of Chief Operating Officer in May 2006. Blair Mullin, a Partner in the Portland practice of Tatum, LLC, was appointed Chief Financial Officer in August 2006. Axel Bernstorff was promoted to Vice President Global Sales from his previous position of Director, Europe Sales in September 2006 and Jack Hilliard was promoted to Corporate Controller from his previous position of Manager Finance in September 2006.



In September 2006, we announced cost reductions that would result in operating costs decreasing in 2007 by $2.5 million from 2006.  These reductions in expense are not expected to have a detrimental effect on either revenue gains or continued software development. Market opportunities for Qix are increasing, therefore we expect that our marketing and development costs for Qix could be higher than previously forecast. We have also taken steps to augment our sales staff to support the growth of Qix.



During the 3GSM World Congress in Barcelona, Spain, February 12  15, 2007, we announced several new products as follows:

•

a new version of our award-winning search and discovery engine QixTM, the Qix v1.10 for S60, now available for operator deployment, which supports the latest phones available in the market that use the S60 3rd Edition platform. The Symbian OS S60 platform is one of the world's leading smartphone platforms, offered on millions of devices and supporting thousands of available mobile applications on the market.

•

QixLinksTM and QixLinks AdsTM, two radical new developments of our award-winning on-device search and discovery engine Qix. These products offer users direct access to portal content and advertisements, driving greater ARPU for operators.

•

Qix for Windows Mobile5 (WM5) which is now available for operator deployment.  According to a report published by RBC Capital Markets, it is expected that 30 million Windows Mobile Smartphones will ship in 2007 around the globe.  We expect to extend support to Windows Mobile 6 by the end of the year.



In the fourth quarter of 2006, we announced a contract with T-Mobile to incorporate Qix into its wireless mobile devices.  The agreement calls for an upfront fee plus a unit license fee for every handset embedded with Qix sold by the operator. If theres a successful initial market introduction of Qix through T-Mobile we expect it will be followed by large-scale deployment on Nokia N70 phones and service will be available on other models during the course of 2007.



In the fourth quarter we were selected as the first-prize winner of the prestigious Orange Innovation Contest at the Orange Partner Camp held in Cadiz, Spain on October 23-25, 2006. Qix was selected by a panel of judges representing strategic product development and marketing areas from Orange and France Telecom after two rounds of assessments among a large number of contestants.



In fourth quarter, we announced several other licensing agreements including:

•

Access Systems Americas, Inc. to pre-integrate eZiText predictive text technology and Decuma handwriting recognition technology into the Access Linux Platform

•

Sony Computer Entertainment Inc. to include our leading eZiText predictive text technology solution for use with the PLAYSTATION®3 (“PS3TM”) computer entertainment system.



Critical Accounting Policies and Estimates



The preparation of the Company's consolidated financial statements requires the use of estimates and judgments that affect its reported amount of assets, liabilities, revenues and expenses. On an ongoing basis, the Company evaluates its estimates, including those related to asset impairment, revenue recognition, contingencies and litigation. These estimates are based on information that is currently available to the Company and on various other assumptions that it believed to be reasonable under the circumstances. Actual results could vary from those estimates under different assumptions and conditions.



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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:



Going Concern Basis



As at December 31, 2006, the Company had an accumulated deficit of $108,575,499, incurred a loss of $10,994,884 for the year and used cash in operating activities of $7,367,154. Continuing operations are dependent on us achieving profitable operations and being able to raise additional capital to meet our obligations and repay liabilities arising from the normal operations when they come due.



We are executing a business plan to allow it to continue as a going concern.  We plan to reduce expenses, as well as continue to sign new customer contracts in 2007 and the future.  The Company can give no assurance that it will be successful in executing this plan.  Should we fail to raise sufficient capital or earn additional revenue we may be forced to suspend our operations, and possibly even liquidate our assets and wind-up and dissolve the Company.



Subsequent to year-end we completed the first part of the business plan by completing a private placement for gross proceeds of $6,000,712 (see additional discussion under the Subsequent Events  Private Placement section).  In addition to this, a significant receivable in the amount of $3.0 million was collected from our single largest customer.  This receivable was used to secure the $1.0 million in bank indebtedness at year-end.  Consequently, the bank indebtedness was repaid from the proceeds of this receivable.



These consolidated financial statements are prepared on a going concern basis, which assumes that we will be able to realize our assets at the amounts recorded and discharge our liabilities in the normal course of business in the foreseeable future.  Should this assumption not be appropriate, adjustments in the carrying amounts of the assets and liabilities to their realizable amounts and the classifications thereof will be required and these adjustments and reclassifications may be material.



Software Development Costs



All research and development costs are expensed as incurred except those that meet the criteria of 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 after technological feasibility of a project is established.



The determination of whether a project is technically feasible involves management judgment.  We determine that a product is technically feasible when 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 product, consistent with the product design, is complete and tested. Capitalized costs are amortized over three years commencing in the period of the product's commercial release.



Revenue Recognition



We recognize revenue when it is earned and realized in a manner consistent with interpretations in Staff Accounting Bulletin No. 104 of the U.S. Securities and Exchange Commission (SEC) as further described in note 3 to the audited consolidated financial statements. Revenue from licensed software is recognized in accordance with Statement of Position ("SOP") 97-2, "Software Revenue Recognition". The application of these rules requires judgment, including, but not limited to, estimating the probability of collection of the receivables resulting from the sale, assessing whether or not all vendor obligations  i.e., obligations borne by us - have been satisfied and whether or not there is sufficient evidence to support the fair value of the various elements in a multi-element agreement. Changes to any of these elements could have a material impact on the amount of earned and unearned income.



Stock-Based Compensation Plan



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We account for stock-based compensation in accordance with SFAS No. 123(R), Share-Based Payment. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating expected terms of the awards. In addition, judgment is also required in estimating the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

Contingencies

The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. SFAS No. 5, Accounting for Contingencies, requires that an estimated loss from a loss contingency such as a legal proceeding or claim should be accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial position or our results of operations.

Accounting for Income Taxes



We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carry forwards. Deferred tax assets and liabilities and operating loss carry forwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss carry forwards are expected to be recovered or settled. A valuation allowance is established when necessary to reduce deferred tax assets to the amount to be expected to be realized. Management must make assumptions, judgments and estimates to determine our current provision for income taxes, our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset. Our judgments, assumptions and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax law or our interpretation of tax laws and future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.

Recent accounting pronouncements



In February 2006, the FASB issued Staff Position No. FAS 123(R)-4, Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event (FSP 123R-4). FSP 123R-4 amends SFAS 123(R) to incorporate that a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employees control does not meet certain conditions in SFAS 123(R) until it becomes probable that the event will occur. The guidance in this FASB Staff Position was applied as part of our adoption of SFAS 123(R), effective January 1, 2006, and did not have a significant impact on the Companys financial results.



In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments - an amendment of SFAS No. 133 and 140, which is effective for fiscal years beginning after September 15, 2006. The statement was issued to clarify the application of SFAS No. 133 to beneficial interests in securitized financial assets and to improve the consistency of accounting for similar financial instruments, regardless of the form of the instruments. The Company has evaluated the new interpretation and determined that it will not have a material impact on the Companys financial results.



In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109), which is effective for fiscal years beginning after December 15, 2006 with earlier adoption encouraged. This interpretation was issued to clarify the accounting for uncertainty in income taxes recognized in the financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company is currently evaluating the new statement to determine the potential impact, if any, this would have on the Companys financial results.



34

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In June 2006, Emerging Issues Task Force Issue 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities should be Presented in the Income Statement (That is, Gross versus Net Presentation) (EITF 06-3), was issued, which is effective for interim and annual reporting periods beginning after December 15, 2006.  EITF 06-3 addresses which taxes assessed by a Government Authority should be considered and how these taxes should be presented in the income statement  i.e., gross versus net. EITF 06-3 reached a consensus that the presentation of the taxes is an accounting policy decision that should be disclosed pursuant to Opinion 22. The Company has adopted the EITF as of December 31, 2006 and it does not have an  impact on the Companys consolidated operations and financial condition.



In September 2006 the FASB issued SFAS No. 157 Fair Value Measurements, which is effective for fiscal years beginning after November 15, 2007. The statement provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. The Company has evaluated the SFAS and has determined that adopting it will not have a significant impact on the Companys consolidated operations and financial condition.



In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 establishes an approach that requires quantification of financial statement errors based on the effects of each of the companys balance sheet and statement of operations and the related financial statement disclosures. Early application of the guidance in SAB 108 is encouraged in any report for an interim period of the first fiscal year ending after November 15, 2006, and will be adopted by the Company in the first quarter of fiscal 2007. The Company has evaluated the SFAS and has determined that adopting it will not have a significant impact on the Companys consolidated operations and financial condition.



In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB Statement No.115.The statement provides companies with an option to report selected financial assets and liabilities at fair value. This Statement is effective as of the beginning of an entitys first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of Statement 157. The Company has not yet estimated the impact, if any, of the new standard.



The SEC has recently required some registrants to restate their previously issued financial statements related to accounting for share purchase warrants issued in a currency other than the functional currency.  In the SECs view, these warrants are to be considered a derivative instrument and accounted in accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities.  SFAS 133 requires derivative instruments be recorded as a liability, instead of a component of shareholders equity, and marked to market value at each reporting period.  The FASB met recently and concluded that the position required by the SEC was correct, but that entities would be allowed until 2008 to adopt it, and would then be able to do so as a change in accounting policy.  However, early adoption would not be permitted, meaning that entities changing currently would have to restate their financial statements.  The FASB position appears to imply that either method is currently correct but that only the SEC position will be correct in 2008. The Company has assessed the FASBs comments to determine what, if any, impact it will have on the Companys financial statements.  As at December 31, 2006, the Company does not have any outstanding warrants that meet the definition of a derivative under SFAS 133; however, the Company has had warrants over its life that did meet this definition.  As a result, the Company could be required to record a significant cumulative adjustment to the Companys opening accumulated deficit in 2008.

Quarterly Overview



The following table summarizes selected unaudited quarterly financial data from continuing operations for the past eight fiscal quarters:



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|                                        |   | 2006               
|--------------------------------------- | - | -------------------
|(In millions, except per share amounts) |   | Fourth
  
  Quarter
|                                        |   |                    
|Revenues                                | $ | 3.2                
|Selling, general and administrative     |   | 3.2                
|Legal                                   |   | 0.8                
|Product, research and development       |   | 0.9                
|Depreciation and amortization           |   | 0.5                
|Operating loss                          |   | (2.3)              
|Net loss                                | $ | (3.0)              
|Loss per share                          |   |                    
|Basic and diluted                       | $ | (0.06)             





|                                        |   | 2005               
|--------------------------------------- | - | -------------------
|(In millions, except per share amounts) |   | Fourth
  
  Quarter
|                                        |   |                    
|Revenues                                | $ | 2.7                
|Selling, general and administrative     |   | 2.2                
|Legal                                   |   | 0.7                
|Product, research and development       |   | 1.0                
|Depreciation and amortization           |   | 0.3                
|Gain on Settlement of Litigation        |   | -                  
|Impairment of note receivable           |   | -                  
|Operating income (loss)                 |   | (1.8)              
|Net loss                                | $ | (2.1)              
|Loss per share                          |   |                    
|Basic and diluted                       | $ | (0.05)             



The net loss for the 2006 fourth quarter was $3.0 million, or a loss per basic and diluted share of $0.06, compared to a net loss of $2.1 million, or a loss of $0.05 per basic and diluted share, in the prior year period.  The results for the fourth quarter of 2006 included $0.8 million in stock-based compensation expense; and provision for the impairment of the note receivable with Archer of $0.1 million, all of which was not present in the fourth quarter of the prior year.



Revenues in the fourth quarter of 2006 were $3.2 million.  This compares to the 2005 fourth quarter revenues of $2.7 million and 2006 third quarter revenues of $2.8 million, increases of 17% and 14%, respectively.  The $0.5 million year-to-year increase in quarterly revenue was due to increased revenues from our largest customer, revenues derived from licensing our software to one of the major players in the gaming industry, and up front fees recognized from our first license agreement with Qix.



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SG&A expense for the 2006 fourth quarter was $3.2 million compared to $2.2 million for the fourth quarter of 2005 and $2.7 million in the third quarter of 2006. The increase was due primarily to $0.7 million of stock-based compensation expense during the quarter, provisions for doubtful accounts of $0.1 million and $0.2 million of incremental professional fees relating to the audit by Canada Revenue Agency of our cross border transactions, and other non-recurring employee-related costs.



We continue to invest in new product features and enhancements to software language databases along with continued investment in Decuma handwriting recognition software and Qix.  PR&D expense, net of capitalized costs, for the 2006 fourth quarter was $0.9 million compared to $1.0 million in the respective prior year period.  We capitalized $0.3 million in the 2006 fourth quarter compared to $0.2 million in the respective period in 2005.



Legal costs for the 2006 fourth quarter was $0.8 million compared to $0.7 million for the respective period last year. The year-over-year increases in legal expense for the 2006 fourth quarter were due, in part, to defense costs related to the University of Texas action against numerous manufacturers of cell phones, of which one of the remaining defendants is a customer of Zi in the United States.  Additionally, there have been certain legal disputes between the Company and a significant shareholder of the Company.



Operating Results



Net Loss

|(In millions, except percentages and per share amounts) |              | 2006 |          | 2005 |   | 2004   |  | Percent |        | Percent
|------------------------------------------------------- | ------------ | ---- | -------- | ---- | - | ------ |  | ------- | ------ | -------
|Change  2006                                            | Change  2005
|versus 2005                                             | versus 2004 
|                                                        |              |      | restated |      |  
|Revenue                                                 |              | $    | 11.8     |      | $ | 10.6   |  | $       | 12.9   |        
|Operating loss                                          |              | $    | (8.9)    |      | $ | (4.1)  |  | $       | (1.7)  |        
|Discontinued operations                                 |              | $    | 1.2      |      | $ | 0.8    |  | $       | 0.7    |        
|Net Loss                                                |              | $    | (11.0)   |      | $ | (5.3)  |  | $       | (2.7)  |        
|Loss per share                                          |              |      | (0.24)   |      |   | (0.12) |  |         | (0.07) |        

The above table has been reclassified to reflect the results from continuing operations.



In 2006, our focus was in laying the ground work for the launch of Qix, while optimizing our costs.



Our net loss in 2006 increased over 2005 primarily for the following reasons:

•

an increase in legal expenses of $1.7 million (see additional discussion under the Operating Results  Legal section);

•

an increase in compensation costs of $1.5 million resulting from the initial implementation of SFAS 123(R) stock based compensation;

•

an increase of $0.5 million in bad debt expense as a result of competitive pressures being  experienced by some of our Asian-based customers;

•

a $1.4 million gain recognized in 2005 from the settlement of a litigation; and

•

the increase in the loss from discontinued operations of $0.4 million resulting from the inclusion of Archers operations.



Our SFAS 123(R) stock based compensation expense totaled $1.5 million for the year. 2006 was the first year we were required to recognize an expense for this purpose. In the fourth quarter, we recognized $0.8 million of stock based compensation expense which was more than the amounts recognized in each of the preceding three quarters. This was a one-time event the circumstances of which are not expected to recur. We expect stock based compensation expense in 2007 to be less than 2006.



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The increase in net loss in 2005 compared to 2004 is primarily attributable to the following:

•

a decline in revenue in our North America market due to significantly lower royalties being generated from a customer that had historically been a significant source of our revenues;

•

less revenue from our Asian market as a result of continued market pressures from outside competitors;

•

increased legal fees of $0.8 million (see additional discussion under the Operating Results  Legal section);

•

increased product research and development costs (PR&D) of $1.8 million attributable to the acquisition of Decuma and lower levels of capitalization;

•

increased income tax expense of $0.4 million related to our Chinese subisidiary, Huayu Zi Software Technology (Beijing) Co. Ltd. ("Huayu Zi") (see additional discussion under the Operating Results  Income Tax section); and,

•

offset by less impairment recognized on note receivables of $1.8 million and a $1.4 million gain recognized in 2005 from the settlement of a litigation.



Revenue

|In millions, except percentages            |             | 2006 |      | 2005 |   | 2004 |  | Percent |      | Percent
|------------------------------------------ | ----------- | ---- | ---- | ---- | - | ---- |  | ------- | ---- | -------
|Change 2006                                | Change 2005
|versus 2005                                | Versus 2004
|                                           |             |      |      |      |  
|Royalties, license and implementation fees |             | $    | 11.8 |      | $ | 10.6 |  | $       | 12.9 |        
|                                           |             |      |      |      |   |      |  |         |      |        

The above table has been reclassified to reflect the results from continuing operations.



License and implementation fees are one time fees charged at the outset of the relationship for licensing our technology and for providing services with implementing or customizing our technology for use on their platforms.  Maintenance and support fees are generated as those services are provided.  Software licensing royalties are ongoing revenues based on the number of units shipped with our product embedded.



In 2006, while the bulk of our revenue continues to be derived by the licensing of eZiText, we introduced Qix to the market with a contract with T-Mobile to incorporate Qix into its wireless mobile devices.  In addition to this, we continue to make progress with the licensing of our Decuma product.



The increase in the 2006 revenues as compared to the 2005 revenues is primarily due to the following:  1) our penetration into the gaming console market, and 2) additional revenues recognized from our largest customer.  In the gaming console market, we announced the licensing of eZiText to Sony Computer Entertainment Inc. for their Playstation 3 and PSP consoles, and to Nintendo Co., Ltd. for their Nintendo Wii console.  In addition to this, we also licensed Decuma to Nintendo for its Nintendo DS console.



While many of our Asian-based customers have continued to feel strong competitive pressures which have resulted in higher bad debt expense and reduced revenues for Zi, we have been able to offset these effects by signing agreements with new licensees in Asia.



The decline in revenue in 2005, compared to 2004, was due to lower revenues in our North America market, which was a result of significantly lower royalties being recognized from a customer that had historically been a significant source of our revenue.  In addition, we had lower revenues from our Asian market as a result of continued pressures from outside competitors.



License Revenue by Geographic Region



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The following table sets forth the revenues recognized by the entities established in each geographic region we operate in with our core technologies  i.e., eZiText, Decuma and Qix.



|In millions, except percentages |             | 2006 |     | 2005 |   | 2004 |  | Percent |     | Percent
|------------------------------- | ----------- | ---- | --- | ---- | - | ---- |  | ------- | --- | -------
|Change 2006                     | Change 2005
|versus 2005                     | versus 2004
|                                |             |      |     |      |  
|Canada                          |             | $    | 5.8 |      | $ | 4.2  |  | $       | 5.9 |        
|United States                   |             |      | 0.9 |      |   | 1.0  |  |         | 1.8 |        
|Asia                            |             |      | 4.8 |      |   | 5.0  |  |         | 5.2 |        
|Sweden                          |             |      | 0.3 |      |   | 0.4  |  |         | 0.0 |        

* Not meaningful



Significant customers



The following table sets forth the customers who accounted for 10% or more of our total license and implementation fees and the percentage of sales generated by the top five customers in the three years ended December 31:





|(In millions, except percentages) |             | 2006 |     | 2005 |  | 2004 |  | Percent |     | Percent
|--------------------------------- | ----------- | ---- | --- | ---- |  | ---- |  | ------- | --- | -------
|Change 2006                       | Change 2005
|versus 2005                       | versus 2004
|                                  |             |      |     |      | 
|Significant Customer  1           |             |      | 25% |      |  | 18%  |  | 20%     |     | 39%    
|Significant Customer  2           |             |      | 9%  |      |  | 13%  |  |         | 14% |        
|Top Five Customers                |             |      | 43% |      |  | 42%  |  |         | 47% |        



Net sales to these significant customers have been attributed to our Canadian operations.



Cost of Sales & Gross Margin

Cost of sales includes the allocation of engineering expenditures associated with projects carried out to modify existing products to meet specific customer requirements and to provide assistance with implementing our product onto our licensees platforms.  Gross margin for 2006 remained relatively consistent compared to prior periods.



Selling, General and Administrative Expenses

|In millions, except percentages   |             | 2006 |      | 2005 |   | 2004 |  | Percent |     | Percent
|--------------------------------- | ----------- | ---- | ---- | ---- | - | ---- |  | ------- | --- | -------
|Change 2006                       | Change 2005
|versus 2005                       | versus 2004
|Selling, General & Administration |             | $    | 11.1 |      | $ | 9.1  |  | $       | 8.7 |        

The above table has been reclassified to reflect the results from continuing operations.



Salaries, general and administrative expense (SG&A) includes salaries and benefits, stock-based compensation and other employee related expenses of sales, finance, in-house legal, facilities and human resources functions. It also includes the cost of professional fees, excluding legal fees, rent, business taxes, bad debts and other administrative expenses.

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The increase in SG&A costs in 2006 is primarily due to costs associated with the initial adoption of SFAS 123(R), which resulted in an additional compensation expense of $1.2 million being recognized in 2006, compared to 2005.  In addition, bad debt expense increased by $0.5 million as a result of competitive pressures among our Asian-based customers. The decline in costs related to Sarbanes-Oxley Act ("SOX") compliance work, which was a significant factor for the increase in 2005, was offset by costs incurred in connection with our international tax audit and transfer pricing consulting fees.



We expect that SG&A expenses will decline in 2007 because we expect that the expenses related to stock based compensation to decline from the 2006 level.



The increase in SG&A in 2005, compared to 2004, was primarily due to the consolidation of, at that time, the recently acquired Decuma.  Other factors also impacting the increase in SG&A are as follows: increased costs associated with SOX and other compliance and increased marketing related costs associated with promoting Decuma and Qix. The increased costs in 2005 were partially offset by the absence of a one-time $1.4 million expense related to the issuance of restricted stock units and non-employee stock option in 2004.

Legal

|In millions, except percentages |             | 2006 |     | 2005 |   | 2004 |  | Percent |     | Percent
|------------------------------- | ----------- | ---- | --- | ---- | - | ---- |  | ------- | --- | -------
|Change 2006                     | Change 2005
|versus 2005                     | versus 2004
|Legal                           |             | $    | 3.4 |      | $ | 1.7  |  | $       | 0.8 |        

The above table has been reclassified to reflect the results from continuing operations.



Legal expenses relate to fees incurred with outside legal counsel for patent protection work, the defense of our patents, shareholder issues and other corporate matters. The sharp increase in legal costs in 2006 are primarily due to the ongoing defense costs related to the University of Texas action against certain of our clients and legal matters related to a major shareholder (see additional discussion under the Litigation/Indemnification section). On February 23rd, 2007, we announced that we have entered into an agreement with the major shareholder to settle all claims.



As a result of the settlement and generally, we expect legal expense to decrease significantly in 2007.



The increase in Legal costs in 2005 over 2004 is attributable to the University of Texas action and the major shareholder legal matters discussed above.



Product Research and Development Expense

|In millions, except percentages        |             | 2006 |       | 2005 |   | 2004  |  | Percent |       | Percent
|-------------------------------------- | ----------- | ---- | ----- | ---- | - | ----- |  | ------- | ----- | -------
|Change 2006                            | Change 2005
|versus 2005                            | versus 2004
|Gross Product Research and Development |             | $    | 5.7   |      | $ | 4.6   |  | $       | 3.5   |        
|Capitalized costs                      |             |      | (1.4) |      |   | (0.9) |  |         | (1.7) |        
|Product Research and Development       |             |      | 4.3   |      |   | 3.7   |  |         | 1.8   |        

The above table has been reclassified to reflect the results from continuing operations.



PR&D expenses include salaries, benefits, stock-based compensation expense and other employee related costs. PR&D costs also include third-party development and programming costs and linguists. Gross expenditures on product development (expenditures before capitalization of costs related to new product development) increased in 2006, compared to 2005, reflecting the impact of the initial adoption of SFAS 123(R), which increased PR&D related compensation expense by $0.3 million.  In addition to this, we increased the relative head count with PR&D related departments, reflecting our commitment to invest in new product features and enhancements to our suite of products.



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Gross PR&D expenditures increased in 2005, compared to 2004, as a result of the acquisition of Decuma and continued investment in new product features and enhancements to software language databases.



Depreciation and Amortization

|In millions, except percentages                    |             | 2006 |     | 2005 |   | 2004 |  | Percent |     | Percent
|-------------------------------------------------- | ----------- | ---- | --- | ---- | - | ---- |  | ------- | --- | -------
|Change 2006                                        | Change 2005
|versus 2005                                        | versus 2004
|Depreciation                                       |             | $    | 0.4 |      | $ | 0.4  |  | $       | 0.3 |        
|Amortizaton of deferred software development costs |             |      | 1.1 |      |   | 0.6  |  |         | 0.5 |        
|Amortizaton of other intangibles                   |             |      | 0.2 |      |   | 0.2  |  |         | -   |        

The above table has been reclassified to reflect the results from continuing operations.

* Not meaningful



The table above sets out the components of depreciation and amortization expense. The increase in depreciation and amortization in 2006 and 2005 was due to increased amortization associated with the commercial release of the S60 version of eZiText and Qix. The commercial release of a product commences the amortization of previously capitalized software development costs related to that product.  We commercially released the S60 version of eZiText and Qix in January 2006, and July 2006 respectively.



In 2005 the increase in the amortization in other intangibles is due to the acquisition of Decuma and the patents and trademarks associated with it.



Interest and Other Income

Interest and other income consist primarily of income from our interest bearing deposits. Interest and other income declined in 2006 as our cash position (including restricted cash) decreased to $3.8 million from $11.4 million in 2005.



Income Tax Expense

We account for income taxes in accordance with FASB SFAS No. 109, Accounting for Income Taxes (SFAS 109). Deferred tax assets and liabilities arise from temporary differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years. These temporary differences are measured using enacted tax rates. A valuation allowance is recorded to reduce deferred tax assets to the extent that management considers it is more likely than not that a deferred tax asset will not be realized. In determining the valuation allowance, management considers factors such as the past history of operating losses, projected taxable income, reversal of deferred income tax liabilities, and the character of income tax assets and tax planning strategies. A change to these factors could impact the estimated valuation allowance and income tax expense.



Except for our Chinese subsidiary, we incurred losses in 2006, 2005 and 2004, the tax benefits of which have not been reflected in the financial statements. A valuation allowance equivalent to the full value of the deferred tax assets of $18.4 million is reflected in the consolidated financial statements resulting in no deferred tax asset being recognized.



We have net operating losses carry forwards of approximately $75.8 million, which can be applied against future years' taxable income in their respective jurisdictions. In addition, we have $50.9 million of capital losses carry forward which are available to offset Canadian capital gains in future years. Taxable income earned by our 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.



We are subject to examinations by taxation authorities of the jurisdictions in which we operate in the normal course of operations. In 2006, Canada Revenue Agency (CRA) commenced an audit of Zi Corporation. We intend to present to CRA a comprehensive review of our international transfer pricing policies and procedures and documentation requirements. We expect that this review will resolve the Zi tax audit but could also result in tax consequences for various Zi subsidiaries. The ultimate resolution of this matter is uncertain and we are currently working with our tax advisors to determine a range of possible outcomes.  Accordingly, we have not recorded any liability relating to this audit as of December 31, 2006.



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Discontinued Operations

Subsequent to year-end, we sold our minority interest in Archer, which represented our now-discontinued operations in the e-Learning business segment, for total proceeds of CDN$736,800, or $632,601 U.S. Dollar equivalent (see additional discussion under Subsequent Events - Disposition of Archer Education Group section).



The completion of this sale represents the end to our involvement in the e-Learning business segment.  As a result, for the years ended December 31, 2006, 2005 and 2004, the e-Learning business segment has been classified as, or in the case of the 2005 and 2004 year-end, reclassified to discontinued operations.



The following table shows the impact of e-Learning on our revenue and expenses in the last three years. As the result of the sale, we will no longer be required to include any part of the operating results of Archer.



|(In millions, except percentages)                      | 2006     |       | 2005     |   | 2004  |  | Percent |       | Percent |    | Percent
|------------------------------------------------------ | -------- | ----- | -------- | - | ----- |  | ------- | ----- | ------- | -- | -------
|of total                                               | of total |       | of total
|2006                                                   | 2005     |       | 2004    
|Revenue                                                | $        | 0.6   |          | $ | 0.8   |  | $       | 0.5   |         | 5% |        
|Expenses                                               |          |       |          |   |       |  |         |       |         |    |        
|Cost of Sales                                          |          | 0.0   |          |   | 0.2   |  | $       | 0.1   |         | *  |        
|Product Research and Development                       |          | 0.1   |          |   | 0.6   |  |         | 0.5   |         | 2% |        
|Selling General and Administrative                     |          | 0.8   |          |   | 0.8   |  |         | 0.6   |         | 7% |        
|Operating Loss                                         |          | (0.4) |          |   | (0.8) |  |         | (0.7) |         | 4% |        
|Equity in net loss of significantly influenced company |          | 0.9   |          |   |       |  |         |       |         |    |        

* not meaningful



Impact of Inflation and Changing Prices

Inflation is not a major factor affecting operations.



Foreign Currency

All non-U.S. operations of ours are translated into U.S. dollars for financial statement presentation. Consequently, movements in exchange rates may have a significant impact on financial results. Substantially all of our product revenues are denominated in U.S. dollars while expenses are denominated in Canadian dollars, Hong Kong dollars, U.S. dollars, Swedish Kronor and Chinese Renminbis. Based on the 2006 distribution of revenues and cash flows, a one percent change in the U.S. dollar relative to all other named currencies is estimated to affect revenues by nil and expenses by $56,432.



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Impact of Governmental Policies and Other Factors on Operations and Investments

We operate primarily in Canada, the United States of America, China, Sweden and Hong Kong. The market for our 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

|In millions, except percentages) |  | 2006 |       | 2005 |   |       | 
|-------------------------------- |  | ---- | ----- | ---- | - | ----- | 
|Increase                        
|(Decrease)                      
|Cash and cash equivalents        |  | $    | 1.7   |      | $ | 11.5  | 
|Net Cash provided by (used in):  |  |      |       |      |   |       | 
|Operating activities             |  |      | (7.2) |      |   | (0.7) | 
|Financing activities             |  |      | 1.01  |      |   | 2.6   | 
|Investing activities             |  |      | (3.3) |      |   | (2.6) | 



Restricted Cash



Due to Chinese government regulations pertaining to the capitalization of Chinese companies, funds held in our principal Chinese subsidiary, are restricted for use in funding the day-to-day operations of our various Chinese subsidiaries.  These funds are not expected to be fully available to fund our non-Chinese operations in the foreseeable future although we have been able to fund certain activities out of these subsidiary balances.



At December 31, 2006, we held the U.S. dollar equivalent of $2,160,495 (December 31, 2005 - $648,119) in cash classified as restricted through our principal Chinese subsidiary.



Bank Indebtedness



In December 2006, we secured a $1,000,000 credit facility with our principal bank, HSBC Bank Canada. The loan was secured by a single trade receivable of ours, which was insured by Export Development Canada. The outstanding amount on the loan was due on demand, or the earlier of the collection of the receivable or March 1, 2007.  The proceeds of the loan were used to augment our cash balances for operating purposes.



The loan was secured by a first priority interest in all capital assets of the Company. The loan bore interest at LIBOR plus 2%. The loan agreement contains a number of restrictive covenants, all of which we were in compliance with as of December 31, 2006.



The loan and accrued interest thereon was repaid in full on January 12, 2007.

Cash Requirements Outlook

During the past three years, our cash requirements have been met through revenues from operations, proceeds from issuance of our common shares or other securities, through the exercise of common share purchase warrants and options and short term credit facilities from our primary commercial bank.



Capital requirements in 2007 include funding of continued new product development and enhancements to existing products. At current revenue and expense levels, we may not able to fund our continued operations and meet our current obligations.



43

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In order to carry on with our business plan, we just recently completed a private placement for gross proceeds of $6,000,712 (see additional discussion under the Subsequent Events  Private Placement section).  In addition to this, we have also implemented certain cost reductions, and a strategic plan to sign new customer contracts in 2007 and the future.  While we believe that we will be successful in meeting our 2007 capital requirements, we can give no assurances.

Cash applied to Operating Activities

Cash applied to operations in 2006 increased by $6.2 million, compared to 2005, primarily due to an increase in our net loss of $5.7 million and an increase in working capital, excluding cash, of $0.7 million. $2.9 million of the increase in net loss is attributable to various non-cash items such as stock based compensation expense, impairment on note receivable, equity in the net loss of a significantly influenced company, and an increase in depreciation and amortization.  The cash items attributable to the loss are an increase in legal expenses of $1.7 million (see Operating Results  Legal) and the gain on settlement of litigation of $1.4 million which occurred in 2005.



In 2006, working capital, excluding cash, increased by $0.7 million compared to 2005 which saw a decrease of $2.7 million.  The  changes in non-cash working capital  in 2006  and 2005  were primarily due to timing differences in collection of a single trade receivable in each of those years.  The remaining changes in non-cash working capital are due to the net effect of the deconsolidation of the e-Learning division and the increase of deferred revenues.



Cash applied to operations in 2005 was $1.1 million as compared to cash generated from operations of $0.9 million in 2004. The $2.0 million year over year decrease in cash flow from operations was due to an increase in net loss of $2.6 million, adjusted for a decrease in non-cash items of $2.9 million and a decrease of $3.4 million in non-cash working capital.



In 2005, non-cash working capital generated $2.7 million in cash. This was due to an increase in accounts payable and accrued liabilities at December 31, 2005 of $0.1 million, a decrease in accounts receivable by $1.7 million and an increase in deferred revenue of $1.0 million. The increase in accounts payable and accrued liabilities relates to an increase in income taxes payable in PRC, the decrease in accounts receivable relates to the collection of a significant customer receivable that was outstanding at December 31, 2004, and the increase in deferred revenue relates to the same significant customer that at December 31, 2005 had a larger amount of revenue that was unrecognized.

Financing Activities

The Company has financed its operating and investing activities during the last three years principally as follows:



|Year | Method of financing                                                                                                 | Amount                        
|---- | ------------------------------------------------------------------------------------------------------------------- | ------------------------------
|2006 | Bank indebtedness                                                                                                   | $  0.9 million                
|2005 | Issuance of common shares pursuant to exercise of stock options and warrants
Bank indebtedness                      | $  2.3 million
$  0.1 million 
|2004 | Issuance of common shares pursuant to a private placement and exercise of stock options
Settlement of notes payable | $ 12.2 million
$ (1.0) million

Investing Activities

Cash used in investment activities increased in 2006 primarily due to the increase in restricted cash of $1.6 million and an increase in the capitalization of software development costs of $0.4 million.  The increase in restricted cash occurs as cash balances built up in one of our Chinese subsidiaries.  This cash is not readily available to our subsidiaries outside of China.  The increase in the capitalization of software development costs reflects our commitment to offer an array of new product features and enhancements to our suite of products.



On January 26, 2005, the Company purchased the assets of Decuma AB ("Decuma"), a Swedish company specializing in developing and marketing handwriting recognition software. The purchase price consideration included 146,929 common shares of the Company with a value of $1.0 million, cash consideration of $175,254 to settle certain working capital related adjustments and other costs and fees related to the purchase in the amount of $281,348 for a total acquisition cost of $1,456,602.



44

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Commitments and Contractual Obligations



As at December 31, 2006, we did not have any long-term debt; however, we did have current portions of capital lease obligations and deferred inducements received upon entering into new office leases in 2002.



As at December 31, 2005, long-term liabilities included the liabilities of discontinued operations related to the disposition of the Companys e-Learning segment (see discussion under  Operating Results  Discontinued Operations ).



The Company rents premises under operating leases, which expire at various dates up to June 2012.  Annual rentals under these leases for each of the next five years are as follows:



2007
  714,1052008
  588,0222009
  536,4232010
  536,4232011
  536,423Total
  $   2,911,396


Transactions with Related Parties

The following table outlines the Companys related party transactions:

|                                                                       | 2006            | 2005           | 2004          
|---------------------------------------------------------------------- | --------------- | -------------- | --------------
|Legal services provided by a law firm in which a director is a partner | $ 158,078       | $227,883       | $125,708      
|Fees paid on behalf of  significantly influenced company               | $     7,247     | $       760    | $  10,442     
|Management fees paid to a firm owned by a director                     | $             - | $            - | $  30,000     
|Consulting fees paid to a firm owned by a former officer               | $   34,248      | $  49,333      | $  46,067     
|Consulting fees paid to a firm in which an officer is a partner        | $   66,006      | $            - | $            -



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:



|                                                  | 2006             | 2005             | 2004            
|------------------------------------------------- | ---------------- | ---------------- | ----------------
|Due to law firm in which a director is a partner  | $   (57,931)     | $   (47,388)     | $    (5,338)    
|Due from significantly influenced company         | $              - | $              - | $   43,629      
|Due to a company in which an officer is a partner | $   (56,188)     | $              - | $              -



Foreign Exchange



We have not entered into any arrangements to hedge our foreign exchange requirements or its foreign assets.



Off-Balance Sheet Arrangements



We have no off-balance sheet arrangements



Capital Expenditure Commitments

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Our operations require certain ongoing capital expenditures to support the productivity of our staff. This includes offices and furniture and equipment, primarily computers. In addition, we require continuous upgrade of servers, language databases, developer software, and other productivity software. We also purchase significant numbers of mobile phones each year for testing, user experience analysis and sales demonstrations. Most of this equipment is purchased as required and does not require long order times.



C.

Research and development, patents and licenses, etc.



Our intellectual property may be grouped into the following product areas: eZiText, eZiTap, eZiType, Decuma, and Qix. It includes patents, copyrights, trademarks, domain names and trade secrets (people, technical know-how and documents). Historically, most of our research and development activities were dedicated to text input technology.  However, with the introduction of Qix and Decuma the amount previously dedicated to text input technology will now be split across all three product areas.  In addition to this, we are continually looking for new market opportunities.



D.

Trend information.



Trend information has been integrated into the operating discussion above.



Litigation/Indemnification

Commencing on March 11, 2005, the Board of Regents of the University of Texas System (UT) filed federal lawsuits against numerous alleged infringers of U.S. Patent No. 4,674,112 (112 Patent) in the U.S. District Court for the Western District of Texas, Austin Division. Of the named parties, the majority are customers of our principal competitor in the text input market and a few are customers of ours.



We are not a named party in the action.  We have not accepted liability for any indemnity pursuant to our customer license agreements or otherwise. As a result of our efforts the claim against two of our customers was dismissed prior to any defence being filed. Without any admission of liability, we agreed as a business decision to assume the defence of five of our customers. Given the costs involved, we settled the claims against four of our relatively minor customers.



On May 2, 2007, the United States District Court for Western District of Texas issued an Order of Non-Infringement of US Patent No. 4,674,112 against the Plaintiff, The Board of Regents of the University of Texas, and in favor of all remaining Defendants.  The plaintiff has filed an appeal within the statutory 30 day limit for filing the appeal.



We have also undertaken considerable expense in actively protecting our intellectual property and defending against alleged infringement claims. We have incurred substantial costs related to patent infringement litigation in the sum of $1,930,000 for 2006 (2005  $540,000; 2004  $60,000) for defense and settlement of such claims.



On February 22, 2007, we entered into a settlement agreement with the Receiver for the Lancer Fund (the Receiver) to settle any and all outstanding claims and issues between the Receiver, the Lancer Entities and us.  The settlement is conditioned upon the Receiver securing orders from the United States District Court for the Southern District of Florida and the United States Bankruptcy Court for the Southern District of Florida, authorizing the Receiver to execute the Settlement Agreement on behalf of the Lancer Entities.  The settlement is also conditioned upon the parties securing the acknowledgement of the Alberta Securities Commission (ASC) that the ASC will dismiss with prejudice our pending action against the Receiver; that the ASC has no objection to the parties terminating such pending action; and that the ASC will take no further action based on acts of Michael Lauer and others which preceded the Receivers appointment.



On April 10, 2007, a settlement agreement with the Receiver for the Lancer Entities became fully effective. Pursuant to the settlement agreement, the Receiver and the Company agreed to, among other things, immediately discontinue, with prejudice, all litigation and regulatory proceedings of any kind. In addition, the Receiver, the Company and certain current and former directors of the Company have agreed to deliver mutual releases. As a result of the settlement agreement, Michael E. Lobsinger has resigned as a director of the Company. He is replaced as a director by George Tai of Calgary, Alberta.



On November 18, 2005, Mike Donnell (the "Plaintiff") filed a wrongful termination lawsuit against us in the Court of Queen's Bench of Alberta, Judicial District of Calgary. The Plaintiff was the President and Chief Executive Officer of Zi for the period from July 23, 2003 to May 26, 2005, when he submitted his resignation. On December 9, 2005, we filed a Statement of Defense and Counterclaim, denying the Plaintiff's claims. In March 2006, the Company settled these actions. The Company had accrued sufficient settlement costs related to this lawsuit as of December 31, 2005.



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On December 4, 2003, the Company commenced a legal action against former counsel in respect of, among other things, their representation of the Company in a lawsuit, the outcome of which was unfavorable to the Company. As part of its defense, prior counsel filed a cross complaint against the Company for $1.1 million in unpaid legal fees and costs, which has been accrued by the Company in its financial statements. On April 6, 2005, the Company settled this litigation. The Company recorded a gain of $1,415,616 in 2005.



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.



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 judgment 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.



Subsequent Events



Private Placement



On March 29, 2007, the Company completed a brokered private placement in the United States and a non-brokered private placement in Canada of a total of 3,776,848 units priced at $1.61 per unit for gross proceeds of $6,000,712. Each unit consists of one share of the Companys stock and two-fifths of a stock purchase warrant. Each whole stock purchase warrant is exercisable into one share of the Companys stock after six months from the date of closing but before March 29, 2012, at an exercise price of $2.14 per share. As for fees for services, the Company agreed to pay a commission to the placement agent involved in the private placement in the United States equal to eight percent of the gross proceeds of such private placement, with six percent to be paid in the form of cash and two percent to be paid in the form of units, which have been included in the total units above, equal to the price paid per unit. An additional eight percent will be paid on the gross proceeds on the exercise of any share purchase warrants held by investors during the first twelve months following the closing of the private placement in the United States and four percent of the gross proceeds on the exercise of any share purchase warrants held by investors during the second twelve months following the closing of the private placement in the United States. Such placement agent will also be issued warrants to purchase such number of common shares of the Company equal to eight percent of the units issued in the private placement in the United States. Under the terms of the private placement, the units sold in the private placement are subject to statutory restrictions on resale, including hold periods.



Stock Option Grant



On January 10, 2007, the Company granted to directors 250,000 stock options with a fair value of $0.82 per share option under the Companys stock option plans. The value of those shares options, aggregating $205,000 will be amortized over the 12-month vesting period. On January 10, 2007, the Company granted to employees other than senior management and directors 72,000 stock options with a fair value of $0.64 per share option under the Companys stock option plans. The value of those share options, aggregating $46,080, will be amortized over the three-year vesting period.



47

---





On February 28, 2007, the Company granted to an officer and director 400,000 stock options with a fair value of $1.00 per share option under the Companys stock option plans. The value of those share options, aggregating $400,000 will be amortized over the three-year vesting period.



Disposition of Archer Education Group



Effective March 27, 2007, Zi sold its minority interest in Archer to an unrelated third party. The transaction was valued at CDN$0.12 per share for total proceeds of CDN$736,800. The purchase price was paid in full at the date of closing.  For the year ended December 31, 2006 and 2005, Archers operations were reflected in the Companys financial statements through the equity method of accounting and consolidation, respectively. As at December 31, 2006, equity in net loss of Archer had exceeded the Companys investment in Archer.  As a result, the proceeds of CDN$736,800 will be recognized as a gain in the first quarter of 2007.



E.

Off-balance sheet arrangements.



The Company did not have any off-balance sheet arrangements at December 31, 2006.



F.

Tabular disclosure of contractual obligations.



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, 2006 were $1,833 (2005  $9,378). The current portion at December 31, 2006 was $1,833 (2005  $7,541).  The future minimum lease payments under the capital leases are $1,870 in 2007, not including lease interest of $37.  No other payments are required under the capital leases.



Inducements for leasehold improvements received by the Company upon entering into new leases as at December 31, 2006 were $28,634 (2005  $86,079). The current portion at December 31, 2006 was $28,634 (2005  $57,386).



See Item 6 for contractual obligation disclosure related to employees.



The Company rents premises under operating leases, which expire at various dates up to June 2012.  Annual rentals under these leases for each of the next five years are as follows:



2007
  714,1052008
  588,0222009
  536,4232010
  536,4232011
  536,423Total
  $   2,911,396




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 a maximum liability may not be 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 harbor.



Not applicable.



48

---





PART III



Item 18. Financial Statements.



See attached.



Item 19. Exhibits.



The list of exhibits is included following the signature page hereto.



SIGNATURES



The Registrant hereby certifies that it meets all of the requirements for filing on Form 20-F/A and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.



| | ZI CORPORATION                       
| | -------------------------------------
| |                                      
| |                                      
| | Per:                                 
| | Milos Djokovic                       
| | President and Chief Executive Officer
| |                                      
| | Date: June 19, 2007                  
| |                                      
| | Per:                                 
| | Blair Mullin                         
| | Chief Financial Officer              
| |                                      
| | Date: June 19, 2007                  



49

---



ANNUAL REPORT ON FORM 20-F/A

for the year ended

December 31, 2006





EXHIBIT INDEX



|Exhibit
No. 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.                                                                                                                                                                                   
|                 |                                                                                                                                                                                                                                                                      
|4.4+             | 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 dated July 30, 2005, between Zi Corporation and Milos Djokovic.                                                                                                                                                                                 
|                 |                                                                                                                                                                                                                                                                      
|4.6***           | Employment Agreement dated effective April 2, 2001, between Zi Corporation and Dale Kearns, as amended.                                                                                                                                                              
|                 |                                                                                                                                                                                                                                                                      
|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 SEC pursuant to a request for confidential treatment)
|                 |                                                                                                                                                                                                                                                                      
|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.             
|                 |                                                                                                                                                                                                                                                                      
|4.12+++          | Settlement Agreement made February 22, 2007, by and among Zi Corporation, Marty Steinberg (solely in his capacity as court appointed receiver of certain Lancer Entities), Quarry Bay Investments Inc. and Michael Lobsinger.                                      
|                 |                                                                                                                                                                                                                                                                      
|4.13+++          | Interim Executive Services Agreement made August 23, 2006, between Tatum, LLC and Zi Corporation.                                                                                                                                                                    
|                 |                                                                                                                                                                                                                                                                      
|8.1              | List of Subsidiaries (included in Item 4)                                                                                                                                                                                                                            
|                 |                                                                                                                                                                                                                                                                      
|12.1+++          | Section 302 Certification by Blair Mullin, Chief Financial Officer dated March 30, 2007.                                                                                                                                                                             
|                 |                                                                                                                                                                                                                                                                      

50

---



|12.2+++ | Section 302 Certification by Milos Djokovic, Chief Executive Officer dated March 30, 2007.
|------- | ------------------------------------------------------------------------------------------
|        |                                                                                           
|12.3    | Section 302 Certification by Blair Mullin, Chief Financial Officer dated June 19, 2007.   
|        |                                                                                           
|12.4    | Section 302 Certification by Milos Djokovic, Chief Executive Officer dated June 19, 2007. 
|        |                                                                                           
|13.1+++ | Section 906 Certification by Blair Mullin, Chief Financial Officer dated March 30, 2007.  
|        |                                                                                           
|13.2+++ | Section 906 Certification by Milos Djokovic, Chief Executive Officer dated March 30, 2007.
|        |                                                                                           
|13.3    | Section 906 Certification by Blair Mullin, Chief Financial Officer dated June 19, 2007.   
|        |                                                                                           
|13.4    | Section 906 Certification by Milos Djokovic, Chief Executive Officer, dated June 19, 2007.
|        |                                                                                           
|15.1+++ | Audit Committee Charter                                                                   
|        |                                                                                           
|15.2    | 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 Annual Report for December 31, 2003.
|    |                                                                   
|*** | Previously filed on Form 20-F Annual Report for December 31, 2004.
|    |                                                                   
|+++ | Previously filed on Form 20-F Annual Report for December 31, 2006.

51

---

Managements ReportThe 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
judgments. 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 Canadian generally accepted accounting standards and 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]                   
|----------------------------------------- | ---------------------------
|Milos Djokovic                            | Blair
    Mullin           
|President and Chief
    Executive Officer | Chief
    Financial Officer
|June 19, 2007                             |                            

-1-

---

Report of Independent Registered Chartered AccountantsTo the Board of Directors and Shareholders of
Zi Corporation

We have audited the consolidated balance sheets of Zi
Corporation as at December 31, 2006 and 2005 and the consolidated statements of
loss, shareholders equity and cash flows for each of the years in the
three-year period ended December 31, 2006. 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, 2006 and 2005 and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 2006 in accordance with accounting principles generally accepted in the
United States of America.
As described in Note 3 to the consolidated financial
statements, the accompanying consolidated financial statements for the year
ended December 31, 2004 have been restated. We therefore withdraw our previous
report dated March 17, 2006 on those financial statements, as originally filed.
The Company is not required to have, nor were we engaged to
perform, an audit of its internal control over financial reporting. Our audits
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, Canada 
March 29, 2007 except for Notes 13 and 21 which are as of June 15, 2007Comments by Independent Registered Chartered Accountants on
  Canada-United States of America Reporting DifferenceThe standards of the Public Company Accounting Oversight
Board (United States) require the addition of an explanatory paragraph
(following the opinion paragraph) when the financial statements are affected by
conditions and events that cast substantial doubt on the Company's ability to
continue as a going concern, such as those described in Note 2 to the
consolidated financial statements. Although we conducted our audits in
accordance with both Canadian generally accepted auditing standards and the
standards of the Public Company Accounting Oversight Board (United States), our
report to the Board of Directors and Shareholders dated March 29, 2007, except
for Notes 13 and 21 which are as of June 15, 2007, is expressed in accordance
with Canadian reporting standards which do not permit a reference to such
conditions and events in the auditors report when these are adequately
disclosed in the financial statements.
[signed] "Deloitte & Touche LLP"
Independent Registered Chartered Accountants 
Calgary, Canada 
March 29, 2007 except for Notes 13 and 21 which are as of June 15, 2007

-2-

---

Consolidated Balance Sheets

|As at December 31,                                                                                                         |   | 2006          |   | 2005          
|-------------------------------------------------------------------------------------------------------------------------- | - | ------------- | - | --------------
|(All
    amounts in United States of America dollars except share amounts)                                                 |   | See note 21   |   | Restated - see
|                                                                                                                           |   |               |   | note 3 & 21   
|                                                                                                                           |   |               |   |               
|Assets                                                                                                                     |   |               |   |               
|Current assets                                                                                                             |   |               |   |               
|Cash and cash equivalents                                                                                                  | $ | 1,672,847     | $ | 10,779,317    
|Restricted cash                                                                                                            |   | 2,160,495     |   | 648,119       
|Accounts receivable, net of allowance of $936,731
    (2005 - $426,697)                                                    |   | 5,785,954     |   | 3,930,697     
|Prepayments and deposits                                                                                                   |   | 599,963       |   | 558,613       
|Total
    current assets                                                                                                   |   | 10,219,259    |   | 15,916,746    
|Capital assets - net (note 5)                                                                                              |   | 906,094       |   | 1,024,217     
|Intangible assets - net (note 6)                                                                                           |   | 3,421,717     |   | 3,226,051     
|Assets held for discontinued
    operations (note 21)                                                                      |   | -             |   | 2,237,491     
|                                                                                                                           | $ | 14,547,070    | $ | 22,404,505    
|Liabilities and shareholders equity                                                                                       |   |               |   |               
|Current liabilities                                                                                                        |   |               |   |               
|Bank indebtedness (note 7)                                                                                                 | $ | 1,000,000     | $ | -             
|Accounts payable and accrued liabilities (note
    17)                                                                     |   | 4,046,022     |   | 3,539,876     
|Deferred revenue                                                                                                           |   | 4,478,026     |   | 3,723,251     
|Deferred tax (note 11)                                                                                                     |   | 174,400       |   | -             
|Current portion of other long-term liabilities
    (note 8)                                                                |   | 30,467        |   | 64,927        
|Total
    current liabilities                                                                                              |   | 9,728,915     |   | 7,328,054     
|Other
    long-term liabilities (note 8)                                                                                   |   | -             |   | 30,530        
|Liabilities of Discontinued operations
    (note 21)                                                                       |   | -             |   | 1,724,267     
|                                                                                                                           |   | 9,728,915     |   | 9,082,851     
|Contingent liabilities, commitments and guarantees (notes 13 & 15)                                                         |   |               |   |               
|Going
    concern (note 2)                                                                                                 |   |               |   |               
|Shareholders equity                                                                                                       |   |               |   |               
|Share
    capital (note 9)                                                                                                 |   |               |   |               
|Unlimited number of Class A, 9%
    convertible, preferred shares authorized and no shares issued or outstanding           |   | -             |   | -             
|Unlimited number of common
    shares, no par value, authorized, 46,688,624 (2005  46,272,568) issued and
    outstanding |   | 110,635,085   |   | 109,365,824   
|Additional paid-in capital                                                                                                 |   | 3,101,201     |   | 2,114,190     
|Accumulated deficit                                                                                                        |   | (108,575,499) |   | (97,580,615)  
|Accumulated other comprehensive loss                                                                                       |   | (342,632)     |   | (577,745)     
|                                                                                                                           |   | 4,818,155     |   | 13,321,654    
|                                                                                                                           | $ | 14,547,070    | $ | 22,404,505    

|See
    accompanying notes to consolidated financial statements.
|----------------------------------------------------------------
|                                                                
|[signed]                                                        
|Richard D. Tingle                                               
|Chairman of the Board                                           

-3-

---

Consolidated Statements of Loss

|Years ended December 31,                                                        |   | 2006         |   | 2005        |   | 2004          
|------------------------------------------------------------------------------- | - | ------------ | - | ----------- | - | --------------
|(All amounts in United
    States of America dollars except share amounts)      |   | See note 21  |   | See note 21 |   | Restated  see
|                                                                                |   |              |   |             |   | note 3 & 21   
|                                                                                |   |              |   |             |   |               
|Revenue                                                                         |   |              |   |             |   |               
|Royalty, license and implementation fees                                        | $ | 11,836,217   | $ | 10,614,043  | $ | 12,898,838    
|Cost of sales                                                                   |   | 406,463      |   | 355,597     |   | 362,562       
|Gross margin                                                                    |   | 11,429,754   |   | 10,258,446  |   | 12,536,276    
|                                                                                |   |              |   |             |   |               
|Operating expenses                                                              |   |              |   |             |   |               
|                                                                                |   |              |   |             |   |               
|Selling general and
    administrative                                          |   | (11,077,269) |   | (9,066,953) |   | (8,677,758)   
|Litigation and legal
    (note 13)                                              |   | (3,352,763)  |   | (1,670,577) |   | (833,197)     
|Product research and
    development                                            |   | (4,276,836)  |   | (3,681,000) |   | (1,839,727)   
|Depreciation and
    amortization (note 6)                                      |   | (1,667,534)  |   | (1,125,695) |   | (902,240)     
|Impairment of note
    receivable (note 12)                                     |   |             |   | (250,000)   |   | (2,000,000)   
|Gain on settlement of litigation (note
    13)                                  |   |             |   | 1,415,616   |   |              
|Operating loss before
    undernoted                                            |   | (8,944,648)  |   | (4,120,163) |   | (1,716,646)   
|                                                                                |   |              |   |             |   |               
|Interest on capital lease obligation                                            |   | (795)        |   | (3,924)     |   | (25,558)      
|Other interest expense                                                          |   | (17,211)     |   | (2,368)     |   | (30,839)      
|Interest income and other income                                                |   | 227,562      |   | 325,050     |   | 101,679       
|Net loss before
    undernoted                                                  |   | (8,735,092)  |   | (3,801,405) |   | (1,671,364)   
|Impairment of note receivable (note 12)                                         |   | (129,417)    |   |            |   |              
|Income taxes (note 11)                                                          |   | (885,084)    |   | (687,515)   |   | (336,161)     
|Net loss from
    continuing operations                                         | $ | (9,749,593)  | $ | (4,488,920) | $ | (2,007,525)   
|Discontinued operations (Note 21)                                               |   | (1,245,291)  |   | (828,503)   |   | (716,835)     
|Net Loss                                                                        |   | (10,994,884) |   | (5,317,423) | $ | (2,724,360)   
|Basic and diluted loss
    per share from continuing operations (note 9 and 16) | $ | (0.21)       | $ | (0.10)      | $ | (0.05)        
|Basic and diluted loss
    per share from discontinued operations (note 21)     |   | (0.03)       |   | (0.02)      |   | (0.02)        
|Basic and diluted loss per share                                                |   | (0.24)       |   | (0.12)      |   | (0.07)        
|Weighted average
    common shares  basic and diluted                          |   | 46,502,728   |   | 46,152,711  |   | 41,373,309    
|Common shares outstanding, end of year                                          |   | 46,688,624   |   | 46,272,568  |   | 45,225,190    
|See
    accompanying notes to consolidated financial statements.               

-4-

---

Consolidated Statements of Shareholders Equity

|                                                                            |                      |               |                 |                 | Accumulated   |               
|--------------------------------------------------------------------------- | -------------------- | ------------- | --------------- | --------------- | ------------- | --------------
|                                                                            |                      |               |                 |                 | other         | Total         
|                                                                            | Common shares issued | Additional    | Accumulated     | comprehensive   | comprehensive
|                                                                            | shares               | amount        | paid-in capital | deficit         | income (loss) | income (loss) 
|(All amounts in United States
    of America dollars except share amounts) 
|Balance  December 31, 2003                                                 | 39,371,560           | $ 93,957,652  | $ 601,744       | $ (89,538,832)  | $ (739,471)   |               
|Issued on exercise of stock
    options                                     | 1,143,766            | 2,289,957     |                |                |              |               
|Issued under private placement                                              | 3,636,364            | 7,067,885     |                |                |              |               
|Issued restricted stock units                                               |                     |              | 685,767         |                |              |               
|Issued share purchase warrants
    to consultant re private placement       |                     | (141,048)     | 141,048         |                |              |               
|Issued on exercise of share
    purchase warrants                           | 1,073,500            | 2,851,188     |                 |                 |               |               
|Issued stock options to
    non-employee                                    |                     |              | 685,631         |                |              |               
|Net loss                                                                    |                     |              |                | (2,724,360)     |              | (2,724,360)   
|Other comprehensive income from
    foreign currency translation adjustment |                     |              |                |                | 275,834       | 275,834       
|Balance  December 31, 2004,
    restated  see note 3                      | 45,225,190           | $ 106,025,634 | $ 2,114,190     | $ (92,263,192)  | $ (463,637)   | $ (2,448,526) 
|Issued on exercise of stock
    options                                     | 290,967              | 736,867       |                |                |              |               
|Issued on exercise of share
    purchase warrants                           | 609,482              | 1,605,187     |                |                |              |               
|Issued on acquisition of
    subsidiary                                     | 146,929              | 998,136       |                |                |              |               
|Net loss                                                                    |                     |              |                | (5,317,423)     |              | (5,317,423)   
|Other comprehensive loss from
    foreign currency translation adjustment   |                     |              |                |                | (114,108)     | (114,108)     
|Balance  December 31, 2005,
    restated  see note 3                      | 46,272,568           | $ 109,365,824 | $ 2,114,190     | $ (97,580,615)  | $ (577,745)   | $ (5,431,531) 
|Issued on exercise of
    restricted stock units                            | 416,056              | 1,269,261     | (1,269,261)     |                |              |               
|Issued restricted stock units                                               |                     |              | 156,663         |                |              |               
|Employee stock-based
    compensation costs                                 |                     |              | 1,340,706       |                |              |               
|Archer dilution                                                             |                     |              | 758,903         |                |              |               
|Net loss                                                                    |                     |              |                | (10,994,884)    |              | (10,994,884)  
|Other comprehensive income from
    foreign currency translation adjustment |                     |              |                |                | 235,113       | 235,113       
|Balance  December 31, 2006                                                 | 46,668,624           | $ 110,635,085 | $ 3,101,201     | $ (108,575,499) | $ (342,632)   | $ (10,759,771)
|                                                                            |                      |               |                 |                 |               |               
|See accompanying notes to consolidated
    financial statements.           

-5-

---

Consolidated Statements of Cash Flow

|Years ended December 31,                                                 |   | 2006        |   | 2005        |                                 | 2004       
|------------------------------------------------------------------------ | - | ----------- | - | ----------- | ------------------------------- | -----------
|(All amounts in United States
    of America dollars)                    |   | See note 21 |   | See note 21 | Restated - see 
    note 3 & 21
|Net cash flow from (used in)
    operating activities:                   |   |             |   |             |                                 |            
|Net loss                                                                 | $ | (9,749,593) | $ | (4,488,920) | $                               | (2,007,525)
|Items not affecting cash:                                                |   |             |   |             |                                 |            
|Depreciation and amortization                                            |   | 1,707,212   |   | 1,152,294   |                                 | 902,240    
|Impairment of note receivable                                            |   | 129,417     |   | 250,000     |                                 | 2,000,000  
|Stock compensation expense -
    employees                               |   | 1,544,755   |   |            |                                 | 685,767    
|Stock compensation expense 
    non-employees                           |   |            |   |            |                                 | 685,631    
|Loss on dispositions of capital
    assets                               |   | 24,212      |   | 5,929       |                                 | 9,899      
|Decrease (increase) in non-cash
    working capital:                     |   |             |   |             |                                 |            
|Accounts receivable                                                      |   | (2,206,552) |   | 970,865     |                                 | (1,729,140)
|Prepayments and deposits                                                 |   | (59,607)    |   | (42,229)    |                                 | (112,899)  
|Accounts payable and accrued
    liabilities                             |   | 536,725     |   | 334,686     |                                 | (444,234)  
|Deferred revenue                                                         |   | 671,215     |   | 1,143,190   |                                 | 1,604,532  
|Deferred tax                                                             |   | 174,400     |   |            |                                 |           
|Cash flow from (used in)
    operating activities                        |   | (7,227,826) |   | (674,185)   |                                 | 1,594,271  
|Cash flow from (used in)
    financing activities:                       |   |             |   |             |                                 |            
|Proceeds from issuance of
    common shares, net of issuance costs       |   |            |   | 2,342,054   |                                 | 12,209,030 
|Settlement of note payable                                               |   |            |   |            |                                 | (1,000,000)
|Bank indebtedness (note 7)                                               |   | 1,000,000   |   |             |                                 |           
|Payment of capital lease
    obligations                                 |   | (7,545)     |   | (16,141)    |                                 |           
|Cash flow from financing
    activities                                  |   | 992,455     |   | 2,325,913   |                                 | 11,209,030 
|Cash flow from (used in)
    investing activities:                       |   |             |   |             |                                 |            
|Advances to discontinued
    operations                                  |   |            |   | (767,597)   |                                 | (773,258)  
|Note receivable                                                          |   |            |   | (250,000)   |                                 |           
|Purchase of capital assets                                               |   | (304,457)   |   | (277,971)   |                                 | (215,397)  
|Software development costs                                               |   | (1,407,204) |   | (930,264)   |                                 | (1,661,974)
|Other deferred costs                                                     |   | (57,445)    |   | (52,732)    |                                 | (52,397)   
|Acquisition of subsidiaries                                              |   |            |   | (458,466)   |                                 | (68,297)   
|Changes in restricted cash                                               |   | (1,512,376) |   | 114,927     |                                 | (550,281)  
|Cash flow used in investing
    activities                               |   | (3,281,482) |   | (2,622,103) |                                 | (3,321,604)
|Cash flow from (used in)
    discontinued operations                     |   |             |   |             |                                 |            
|Operating activities                                                     |   | (139,328)   |   | (472,888)   |                                 | (664,056)  
|Financing activities                                                     |   | (106,650)   |   | 874,247     |                                 | 773,258    
|Investing activities                                                     |   | (181,199)   |   | 45,312      |                                 | 105,436    
|Cash flow from (used in) in
    discontinued operations                  |   | (427,177)   |   | 446,671     |                                 | 214,638    
|Effect of foreign exchange rate
    changes on cash and cash equivalents |   | 107,556     |   | (93,264)    |                                 | 275,834    
|Net cash (outflow) inflow                                                |   | (9,836,474) |   | (616,968)   |                                 | 9,972,169  
|Cash and cash equivalents,
    beginning of year                         |   | 11,509,321  |   | 12,126,289  |                                 | 2,154,120  
|Cash and cash equivalents, end
    of year                               | $ | 1,672,847   | $ | 11,509,321  | $                               | 12,126,289 
|Cash and cash equivalents held
    in discontinued operations (note 21)  |   |            |   | (730,004)   |                                 | (283,333)  
|Cash and cash equivalents, end
    of year                               | $ | 1,672,847   | $ | 10,779,317  | $                               | 11,842,956 
|Non-cash financing activity                                              |   |             |   |             |                                 |            
|Equipment acquired under
    capital lease                               | $ |            | $ |            | $                               | 29,118     
|Components of cash and cash
    equivalents                              |   |             |   |             |                                 |            
|Cash                                                                     | $ | 1,294,185   | $ | 4,120,256   | $                               | 5,104,654  
|Cash equivalents                                                         | $ | 378,662     | $ | 7,389,065   | $                               | 7,021,635  
|Total cash and cash equivalents                                          | $ | 1,672,847   | $ | 11,509,321  | $                               | 12,126,289 
|Supplemental cash flow
    information                                   |   |             |   |             |                                 |            
|Cash paid for interest                                                   | $ | 18,006      | $ | 6,292       | $                               | 56,397     
|Cash paid for income taxes                                               | $ | 772,260     | $ | 687,515     | $                               |           
|See
    accompanying notes to consolidated financial statements.        

-6-

---

Notes to the Consolidated Financial StatementsFor the years ended December 31,
  2006, 2005 and 2004 (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. The Companys
full range of intuitive and easy-to-use solutions include its new eZiType
predictive keyboard with auto-correction, eZiText® for one-touch predictive text
entry, eZiTap for intelligent multi-tap entry, Decuma® for natural handwriting
which now includes prediction technology and Qix, a search and discovery
engine. Zis markets these products directly to original equipment
manufacturers, original design manufacturers and carriers.

2. Going Concern Basis of Presentation

As at December 31, 2006, the Company had an accumulated
deficit of $108,575,499 and for the year the Company incurred a loss of
$10,994,884 and used cash in operating activities of $7,227,826. Continuing
operations are dependent on the Company achieving profitable operations and
being able to raise additional capital to meet our obligations and repay
liabilities arising from the normal operations when they come due.

The Company is executing a business plan to allow it to
continue as a going concern. The Company plans to reduce expenses, as well as
continue to sign new customer contracts in 2007 and the future. The Company can
give no assurance that it will be successful in executing this plan. Should it
fail to raise sufficient capital or earn additional revenue it may be forced to
suspend its operations, and possibly even liquidate its assets and wind-up and
dissolve the Company.

Subsequent to year-end the Company completed the first part
of its business plan by completing a private placement for gross proceeds of
$6,000,712 (see note 19). In addition to this, a significant receivable in the
amount of $3.0 million was collected from the Companys single largest customer.
This receivable was used to secure the $1.0 million in bank indebtedness at
year-end. Consequently, the bank indebtedness was repaid from the proceeds of
this receivable.

These consolidated financial statements are prepared on a
going concern basis, which assumes that the Company will be able to realize its
assets at the amounts recorded and discharge its liabilities in the normal
course of business in the foreseeable future. Should this assumption not be
appropriate, adjustments in the carrying amounts of the assets and liabilities
to their realizable amounts and the classifications thereof will be required and
these adjustments and reclassifications may be material.

3. Significant Accounting Policies

Basis of presentation

The accompanying consolidated financial statements are
expressed in United States of America dollars ("U.S. dollars") and prepared by
management in conformity with accounting principles generally accepted in the
United States of America ("U.S. GAAP").

Restatement of income tax expense

For the year ended December 31, 2004, the Companys income
tax expense has been restated to reflect actual income tax expense for a
previously understated liability. According to the Peoples Republic of China ("PRC"
or "China") taxation law, those Foreign Investment Entities ("FIE") established
in China that are involved in "productive" activities are entitled to tax
holidays and tax reductions. These FIE tax benefits include a two-year tax
holiday followed by a 50 percent reduction of the otherwise applicable tax rate
for the following three years. Our Chinese subsidiary, Huayu Zi Software
Technology (Beijing) Co. Ltd. ("Huayu Zi") had been categorized as a
productive-type FIE in all of its PRC statutory filings, including its routine
filings to tax authorities and we believed it was entitled to the tax holiday
and tax rate reductions.

PRC tax authorities tightened the scope of FIE tax incentives
and narrowed the tax holiday and reduction entitlement to those entities engaged
in productive activities or engaged in "encouraged" industries. Changes to the
operations of Huayu Zi in 2004 resulted in decreases in its research and
development spending and revenues generated from productive activities (as
defined under the FIE guidelines) which were below the stipulated levels
required to qualify as a FIE eligible for the tax holidays and reductions. As a
result, the Company should have recorded an increase in the income tax liability
and expense of $336,161 for the year ended December 31, 2004. The Company
previously disclosed in its consolidated financial statements for the year ended
December 31, 2004, a contingent liability of $166,871 for 2004 income tax.

Income tax expense for the year ended December 31, 2004,
previously reported as nil, has been restated to $336,161. As a result, the net
loss for the year ended December 31, 2004, previously reported as $2,388,199,
has been restated to $2,724,360. Similarly, net loss per share for the year
ended December 31, 2004, previously reported as $0.06, has been restated to
$0.07. In addition, the accumulated deficit as at December 31, 2004, previously
reported as $91,927,031, has been restated to $92,263,192. Comprehensive net
loss for the year ended December 31, 2004, previously reported as $2,112,365,
has been restated to $2,448,526.

-7-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

As disclosed in the notes to the financial statements under
stock-based compensation, proforma net loss for the year ended December 31,
2004, previously reported as $6,290,102, has been restated to $6,626,263.
Similarly, pro forma net loss per share for the year ended December 31, 2004,
previously reported as $0.15, has been restated to $0.16.

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 Archer
Education Group Inc. ("Archer") (see Discontinued Operations Note 21) and Magic
Lantern Group, Inc. ("MLG"). These investments, which the Company does not
control but exercises significant influence over its operating, investing and
financing policies, are accounted for using the equity method. With respect to
MLG, the Company does not recognize its proportionate share of losses that would
result in a negative carrying value of its equity investment. Since the
deconsolidation of Archer in February of 2006, (See note 4 & 18) the company has
been recognizing its proportionate share of losses until the fourth quarter when
the investment was reduced to zero. Dilution gains triggered by future share
issuance by Archer may cause the investment to be increased at which point the
Company will resume recognizing its proportionate share of losses up to the
amount of the investment. The Consolidated Statements of Loss and Cash Flows
have been restated to reclassify Archer as discontinued operations.

Minority interest in earnings of consolidated subsidiaries
represents the minority shareholders share of the after-tax net income or loss
from Archer prior to the deconsolidation in March of 2006. The minority interest
included in the consolidated balance sheets reflects the original investments by
these minority shareholders in the consolidated subsidiaries, along with their
proportionate share of the earnings or losses of the subsidiaries. As of
December 31, 2005, no value was allocated to minority interest. Archer has
generated losses since its inception; as a result, the Company has not allocated
to minority interests their proportionate share of the losses, as the minority
shareholders do not have any obligation to reimburse the Company their
proportionate share of the losses.

The Company consolidates an entitys financial statements
when the Company either will absorb a majority of the entitys expected losses
or residual returns, in the case of a variable interest entity ("VIE"), which
there were none at December 31, 2006 and 2005, or has the ability to exert
control over a subsidiary. Control is normally established when ownership
interests exceed 50 percent in an entity. However, when the Company does not
exercise control over a majority-owned entity as a result of other investors
having rights over the management and operations of the entity, the Company
accounts for the entity under the equity method. As of December 31, 2006, 2005
and 2004, there were no greater-than-50 percent-owned affiliates whose financial
statements were not consolidated.

Foreign currency translation

Zi Corporations functional currency, on a stand-alone basis,
is the U.S. dollars. For the United States, Swedish, Chinese, Hong Kong and
other Canadian subsidiaries, the functional currencies are the U.S. dollar,
Swedish krona, Chinese renminbi ("RMB"), Hong Kong dollar and Canadian dollar ("CDN"),
respectively. The balance sheet accounts of the Companys foreign operations for
which the local currency is the functional currency are translated into U.S.
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
consolidated statements of loss.

Use of estimates

The preparation of these consolidated financial statements
and related disclosures in conformity with U.S. 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 deferred 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.

-8-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

Restricted cash

At December 31, 2006, the Company held the U.S. dollar
equivalent of $2,160,495 (December 31, 2005 - $648,119) in RMB through its
principal Chinese subsidiary Huayu Zi. Due to PRC government regulations
pertaining to the capitalization of Chinese companies, these funds are available
to fund the day-to-day operations of the Company's various Chinese subsidiaries
and are not expected to be fully available to fund the non-Chinese operations of
the Company in the foreseeable future.

At December 31, 2006 and December 31, 2005, the Company has
classified these funds as restricted cash. The reclassification to restricted
cash does not affect previously reported cash flows from operations or from
financing activities in the Companys previously reported consolidated
statements of cash flows, or its previously reported consolidated statements of
loss for any period.

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 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:

|Customer agreements            | 4.5 years
|------------------------------ | ---------
|Patents and trademarks         | 11 years 
|Software development
    costs | 3 years  
|Curriculum                     | 10 years 
|Contracts relationship         | 10 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, such as, the loss of a patent litigation or a significant decline
in the Companys revenue.

Impairment of long-lived assets

The Company annually reviews the carrying value of its
long-lived assets, including intangible assets, on September 30 of each year and
periodically reviews the carrying value of its long-lived 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 in determining
the fair value of the asset. The Company evaluated its remaining long-lived
assets at September 30, 2006 and determined that no impairment had occurred.

Revenue recognition

Revenues from software licensing royalties related to the
sale of the product in which the Companys technologies have been embedded are
recognized in accordance with Statement of Position ("SOP"), "Software Revenue
Recognition". Software licensing royalties are included in fees from licensing
and implementation.

-9-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

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 once 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.

The Company reports revenue on a gross basis in PRC. The
amount of taxes collected from customers and remitted to the governmental
authorities was $595,157, $522,278 and $434,386 in the three years ended 2006,
2005 and 2004 respectively.

Revenues from Oztime product contracts recorded in other
product revenue were recognized using the percentage of completion method,
whereby revenue was recorded at the estimated realizable value of work completed
to date and costs incurred to date were compared to total estimated contract
costs to determine whether a loss was realized. Amounts received in advance were
recorded as deferred revenue. Estimated losses on contracts were recognized when
they became known.

Revenues from Archer (see note 21) consist primarily of
tuition and fees derived from courses taught in Archers colleges, schools, and
training centers. Revenues from tuition fees are recognized pro-rata (on a
straight-line basis) on a monthly basis over the relevant period attended by the
student of the applicable course or program. If a student withdraws from a
course or program, the paid but unearned portion of the students tuition is
refunded. Refunds are calculated and paid in accordance with applicable
provincial law and accrediting agency standards for refund policies. Textbook
sales and other revenues are recognized as sales occur or services are performed
and represent less than 10 percent of total revenues. Prepaid tuition is the
portion of payments received but not earned and is reflected as a current
liability in the accompanying consolidated balance sheets, as such, amounts are
expected to be earned within the next year.

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 or pro-rata on a monthly
basis, as previously described.

Allowance for doubtful accounts

The Company maintains an allowance for doubtful accounts for
estimated losses resulting from the inability of customers to make payments. The
Company evaluates the credit worthiness of its customers prior to delivery of
its software and based on these evaluations, adjusts credit limits to the
respective customers. In addition to these evaluations, the Company conducts
on-going credit evaluations of its customers payment history and current credit
worthiness. The allowance is maintained for 100% of all accounts deemed to be
uncollectible. To date, the actual losses have been within management
expectations.

As at December 31, 2006, a single customer accounted for 52%
of the accounts receivable balance. Subsequent to December 31, 2006, the full
amount of the receivable was collected.

Income taxes

The Company computes income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes", using the asset and liability method, under
which deferred income taxes are provided for the temporary differences between
the financial reporting basis and the tax basis of the Companys assets and
liabilities and operating loss and tax credit carry forwards. A valuation
allowance is established when necessary to reduce deferred tax assets to the
amount expected to be realized. Deferred tax assets and liabilities and
operating loss and tax credit carry forwards are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences and operating loss and tax credit carry forwards are expected to be
recovered or settled.

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. The Company accounts for tenant improvement allowances as
a deferred rent liability included in other liabilities on the consolidated
balance sheets and as a component of investing activities on the consolidated
statements of cash flows.

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.



-10-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

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 ("RSUs") 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. Potentially diluted shares have not been used in calculating diluted loss
per share for the years ended December 31, 2006, 2005 and 2004 as they were
anti-dilutive as discussed in note 17.

Comprehensive income (loss)

Comprehensive income (loss) 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.

Gains on issuance of stock by subsidiaries

At the time a subsidiary sells its stock to unrelated parties
at a price in excess of its book value, the Companys net investment in that
subsidiary increases. If at that time, the subsidiary is not a newly formed,
non-operating entity, nor a research and development, start-up or development
stage company, nor is there a question as to the subsidiarys ability to
continue in existence, the Company records the dilution gain in the consolidated
statements of loss. Otherwise, the increase is reflected in additional paid-in
capital in the Companys consolidated statements of shareholders equity.

Financial instruments

Accounts receivable, cash equivalents, investment in
significantly influenced company, accounts payable, accrued liabilities, note
payable, and capital lease obligations 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 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,
Asia, 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

The Company adopted SFAS 123(R) "Share Based Payment",
effective January 1, 2006. This pronouncement requires companies to measure the
cost of employee services received in exchange for an award of equity
instruments (typically stock options) based on the grant-date fair value of the
award. The fair value is estimated using option-pricing models. The resulting
cost is recognized over the period during which an employee is required to
provide service in exchange for the award, usually the vesting period. Prior to
the adoption of SFAS 123(R), the Company was required to provide pro forma
disclosures.

The adoption of SFAS 123(R) changes the accounting for stock
options. SFAS 123(R) is effective for all stock options grant beginning January
1, 2006. For those stock option awards granted prior to January 1, 2006, but for
which the vesting periods are not complete, the modified prospective transition
method permitted by SFAS 123(R) is used. Under this method, the Company accounts
for such awards on a prospective basis, with expense being recognized in the
consolidated financial statements beginning in the first quarter of 2006 using
the grant-date fair values previously calculated for pro forma disclosures. The
Company has recognized the related compensation cost not previously recognized
in the pro forma disclosures over the remaining vesting period. Stock options
typically vest in equal installments over a service period. Expense related to
each portion of an option grant is recognized over the specific vesting period
for those options.

The fair value of options is determined at the grant date
using a Black-Scholes closed-form model valuation technique, which requires the
Company to make several assumptions. The risk-free interest rate is based on the
Canadian benchmark bond yield curve in effect for the expected term of the
option at the time of grant. The dividend yield on common stock is assumed to be
zero since the Company does not pay dividends and has no current plans to do so
in the future. The market price volatility of common stock is based on the
historical volatility of the Companys common stock over a time period equal to
the expected term of the option and ending on the last date of the quarter in
which the options were granted. The expected life of the options is based on the
Companys historical experience for various categories of employees receiving
stock option grants. The Company accounts for restricted stock units ("RSUs") in
accordance with SFAS No. 123(R), and records the fair value of the RSUs equal to
the market price on the date of grant with the related compensation expense
recognized over the vesting period.

-11-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

SFAS No. 123(R) also requires that the excess tax benefits
related to stock compensation be reported as a cash inflow from financing
activities rather than as a reduction of taxes paid in cash from operations.

Note 9, below, describes the Companys stock-based
compensation plan. Any consideration paid by employees on exercise of stock
options or purchase of stock is credited to share capital. Compensation expense
related to the exercise of stock options previously credited to additional
paid-in capital is credited to common stock.

Prior to January 1, 2006, the Company accounted for
stock-based compensation using the intrinsic value method as prescribed by APB
Opinion No. 25 and related interpretations. No stock-based compensation related
to option grants to employees or directors was reflected in net loss in the
years ended December 31, 2005 and 2004 as all stock options granted under those
plans had an exercise price equal to or greater than the market value of the
underlying common stock on the date of grant. Had compensation cost for the
plans been determined based on the fair value at the grant dates for awards
under those plans consistent with the method of SFAS 123, the Companys net loss
and basic and diluted net loss per share for the years ended December 31, 2005
and 2004 would have been changed to the pro forma amounts indicated below:

|Years ended December 31,                                                 |   | 2005        |                       | 2004       
|------------------------------------------------------------------------ | - | ----------- | --------------------- | -----------
|                                                                         |   |             | Restated  see note 3
|Net loss:                                                                |   |             |                       |            
|As reported                                                              | $ | (5,317,423) | $                     | (2,724,360)
|Stock compensation expense                                               |   | (2,874,033) |                       | (3,901,903)
|Pro forma net loss                                                       |   | (8,191,456) |                       | (6,626,263)
|Net loss per common
    share:                                           |   |             |                       |            
|As reported, basic and diluted                                           | $ | (0.12)      | $                     | (0.07)     
|Stock compensation expense, basic and diluted                            |   | (0.06)      |                       | (0.09)     
|Pro forma, basic and diluted                                             | $ | (0.18)      | $                     | (0.16)     
|Stock options and RSUs
    issued during the year                        |   | 940,375     |                       | 2,105,500  
|Weighted average exercise price                                          | $ | 3.22        | $                     | 2.27       
|Weighted average fair value of stock
    options granted during the year | $ | 2.22        | $                     | 1.19       

In 2004, a grant of 400,000 stock options was made to a
non-employee consultant for financial advisory services which the company
accounted for in accordance with SFAS No 123 and recognized $685,631 in 2004 as
part of selling general and administrative expense calculated by using the
Black-Scholes option pricing model.

The above pro forma compensation expense
related to options granted pursuant to our stock option plans was determined
based on the estimated fair values using the Black-Scholes Option Pricing Model
and the following weighted average assumptions:

|                        | 2005     | 2004    
|----------------------- | -------- | --------
|Risk free interest rate | 3.0-3.8% | 2.5-3.9%
|Expected life in years  | 3.7      | 3.7     
|Expected dividend yield | 0%       | 0%      
|Expected volatility     | 82-116%  | 45-82%  

Recent accounting pronouncements

In February 2006, the FASB issued Staff Position No. FAS
123(R)-4, "Classification of Options and Similar Instruments Issued as Employee
Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent
Event" ("FSP 123R-4"). FSP 123R-4 amends SFAS 123(R) to incorporate that a cash
settlement feature that can be exercised only upon the occurrence of a
contingent event that is outside the employees control does not meet certain
conditions in SFAS 123(R) until it becomes probable that the event will occur.
The guidance in this FASB Staff Position was applied as part of our adoption of
SFAS 123(R), effective January 1, 2006, and did not have a significant impact on
the Companys financial results.

In February 2006, the FASB issued SFAS No. 155, "Accounting
for Certain Hybrid Financial Instruments - an amendment of SFAS No. 133 and
140", which is effective for fiscal years beginning after September 15, 2006.
The statement was issued to clarify the application of SFAS No. 133 to
beneficial interests in securitized financial assets and to improve the
consistency of accounting for similar financial instruments, regardless of the
form of the instruments. The Company has evaluated the new interpretation and
determined that it will not have a material impact on the Companys financial
results.

-12-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

In June 2006, the FASB issued FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement
No. 109)", which is effective for fiscal years beginning after December 15, 2006
with earlier adoption encouraged. This interpretation was issued to clarify the
accounting for uncertainty in income taxes recognized in the financial
statements by prescribing a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. The Company is currently evaluating the
new statement to determine the potential impact, if any, this would have on the
Companys financial results.

In June 2006, Emerging Issues Task Force Issue 06-3, "How
Taxes Collected from Customers and Remitted to Governmental Authorities should
be Presented in the Income Statement (That is, Gross versus Net Presentation)"
("EITF 06-3"), was issued, which is effective for interim and annual reporting
periods beginning after December 15, 2006. EITF 06-3 addresses which taxes
assessed by a Government Authority should be considered and how these taxes
should be presented in the income statement  i.e., gross versus net. EITF 06-3
reached a consensus that the presentation of the taxes is an accounting policy
decision that should be disclosed pursuant to Opinion 22. The Company has
adopted the EITF as of December 31, 2006 and it does not have an impact on the
Companys consolidated operations and financial condition.

In September 2006 the FASB issued SFAS No. 157 "Fair Value
Measurements", which is effective for fiscal years beginning after November 15,
2007. The statement provides a single definition of fair value, together with a
framework for measuring it, and requires additional disclosure about the use of
fair value to measure assets and liabilities. The Company has evaluated the SFAS
and has determined that adopting it will not have a significant impact on the
Companys consolidated operations and financial condition.

In September 2006, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements" ("SAB 108"). SAB 108 provides guidance on the consideration of the
effects of prior year misstatements in quantifying current year misstatements
for the purpose of a materiality assessment. SAB 108 establishes an approach
that requires quantification of financial statement errors based on the effects
of each of the companys balance sheet and statement of operations and the
related financial statement disclosures. Early application of the guidance in
SAB 108 is encouraged in any report for an interim period of the first fiscal
year ending after November 15, 2006, and will be adopted by the Company in the
first quarter of fiscal 2007. The Company has evaluated the SFAS and has
determined that adopting it will not have a significant impact on the Companys
consolidated operations and financial condition.

In February 2007, the FASB issued SFAS No. 159, "The Fair
Value Option for Financial Assets and Financial Liabilities Including an
amendment of FASB Statement No.115".The statement provides companies with an
option to report selected financial assets and liabilities at fair value. This
Statement is effective as of the beginning of an entitys first fiscal year
beginning after November 15, 2007. Early adoption is permitted as of the
beginning of the previous fiscal year provided that the entity makes that choice
in the first 120 days of that fiscal year and also elects to apply the
provisions of Statement 157. The Company has not yet estimated the impact, if
any, of the new standard.

The Securities and Exchange Commission ("SEC") has recently
required some registrants to restate their previously issued financial
statements related to accounting for share purchase warrants issued in a
currency other than the functional currency. In the SECs view, these warrants
are to be considered a derivative instrument and accounted in accordance with
SFAS 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS
133 requires derivative instruments be recorded as a liability, instead of a
component of shareholders equity, and marked to market value at each reporting
period. The FASB met recently and concluded that the position required by the
SEC was correct, but that entities would be allowed until 2008 to adopt it, and
would then be able to do so as a change in accounting policy. However, early
adoption would not be permitted, meaning that entities changing currently would
have to restate their financial statements. The FASB position appears to imply
that either method is currently correct but that only the SEC position will be
correct in 2008. The Company has assessed the FASBs comments to determine what,
if any, impact it will have on the Companys financial statements. As at
December 31, 2006, the Company does not have any outstanding warrants that meet
the definition of a derivative under SFAS 133; however, the Company has had
warrants over its life that did meet this definition. As a result, the Company
could be required to record a significant cumulative adjustment to the Companys
opening accumulated deficit in 2008.

4. Acquisitions

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 of Decuma AB

On January 26, 2005, the Company purchased the assets of
Decuma AB ("Decuma"), a Swedish company specializing in developing and marketing
handwriting recognition software. The Company has accounted for the purchase
under the purchase method of accounting, and accordingly, included the results
of operations of Decuma in the consolidated operating result of the Company from
the date of acquisition. As part of the acquisition, the Company acquired
Decumas intellectual property and customer agreements. Amounts assigned to
intangible assets were supported through discounted cash flow analyses. Patents
and trademarks are amortized over 11 years. Customer agreements are amortized
over the remaining life of the agreement (up to 4.5 years). The purchase price
consideration included 146,929 common shares of the Company with a value of $1.0
million, cash consideration of $175,254 to settle certain working capital
related adjustments and other costs and fees related to the purchase in the
amount of $281,348 for a total acquisition cost of $1,456,602.

-13-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

Through an assessment process carried out by the Company upon
completion of this acquisition, it was decided that a certain senior management
position in Decuma was redundant. Included in the purchase price is $200,000 to
involuntarily terminate this position.

The purchase price is allocated as follows:

Net assets acquired:Non-cash working
      capital deficiency
      $
      (15,334)Capital assets
      
      49,821Customer agreements
      
      187,100Patents and trademarks
      
      1,235,015$
      1,456,602


Pro forma information has not been presented showing the
effect of a January 1, 2005 acquisition on the current years results as the
effect is not material. The following summarized pro forma information assumes
the acquisition had occurred on January 1, 2004:

Year ended DecemberPro forma information:
      31, 2004 (unaudited)Revenue
      $
      13,907,535Net loss
      
      (3,941,888)Loss per share  basic and diluted
      $
      (0.10)


The pro forma results do not purport to be indicative of
results that would have occurred had the acquisition been in effect for the
period presented, nor do they purport to be indicative of the results that would
be obtained in the future.

Acquisition of Archer Education Group Inc.

Archer was incorporated in February 2005 for the purpose of
acquiring a number of educational learning institutions in Canada. Zi acquired
24.9 percent of Archers shares, through share subscription agreements in 2005.
Consequently, Zi is a related party to Archer.

The Companys ownership of Archer increased primarily by the
sale of its Beijing Oztime Education & Network Technology Co. Ltd. ("Oztime")
and EnglishPractice Inc. ("EPI") subsidiaries to Archer. At December 31, 2005,
the Company held 53.2 percent of the outstanding shares of Archer. Zi therefore,
accounted for its investment in Archer as a purchase under the purchase method
of accounting. Zi included Archers results from December 21, 2005 (the date of
acquisition) to December 31, 2005, and its assets and liabilities, net of
minority interest at December 31, 2005.

Under the sale agreements, Zi received 6,140,000 shares of
Archer, including contingent consideration of 1,000,000 shares placed in escrow
and a RMB 1,000,000 non-interest bearing note receivable. The release of the
escrowed shares is subject to performance criteria requiring revenues earned
through Oztime related operations, from the date of purchase to December 31,
2006, be $2,950,000 or more. The Company determined there was uncertainty that
Oztimes revenues related to its operations would achieve the performance
criteria and as such the contingent consideration was not considered as part of
the sale proceeds. As at December 31, 2006, Oztime revenues earned did not reach
the required level. As a result, the escrowed shares will be cancelled.

On February 28, 2006, Archer raised additional capital
through private placements of common shares at which point Zis interest in
Archer was diluted to 49.9 percent. The Company has deconsolidated the results
of Archer as of March 1, 2006, since it no longer absorbs a majority of the
entities expected losses or residual returns, in the case of a variable interest
entity, and no longer has the ability to exert control over this subsidiary. The
Company has accounted for its proportionate share of Archers net loss at
December 31, 2006, using the equity method.

-14-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

Through a further
private placement of Archers common shares and exercise of stock options from
March to December 2006, the Companys ownership of Archer was diluted to 42.2
percent. As the price of the shares issued by Archer is in excess of the book
value of the underlying share, the Companys net investment in Archer increases
resulting in a dilution gain to Zi of $758,903 as of December 31, 2006, which
was recorded to additional paid-in capital.

Disposition of Archer Education Group Inc.

Effective March 27, 2007, the Company sold its minority
interest in Archer Education Group, Inc. ("Archer") for total proceeds of
CDN$736,800. There were no contingent considerations, or performance criteria in
the sale agreement.

The Companys proportionate share of the loss from Archers
operations for the period ended March 27, 2007 has not been recognized as the
carrying value of the investment in Archer was nil and the Company had no
commitment to fund this loss. In addition to this, Archer did not complete any
private placements between January 1, 2007 and March 27, 2007. Therefore, the
Company was not required to recognize any potential dilution gains resulting in
an increase in its net investment in Archer. As a result, the full amount of the
proceeds were recognized as a gain on disposal of discontinued operations in the
period ended March 31, 2007.

5.

|                                                                                                                                                                                             |   |            |   | Accumulated  |   | Net book 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | ---------- | - | ------------ | - | ---------
|                                                                                                                                                                                             |   | Cost       |   | amortization |   | value    
|2006                                                                                                                                                                                         |   |            |   |              |   |          
|Computer and office equipment                                                                                                                                                                | $ | 3,160,556  | $ | 2,341,331    | $ | 819,225  
|Leasehold improvements                                                                                                                                                                       |   | 563,062    |   | 476,193      |   | 86,869   
|                                                                                                                                                                                             | $ | 3,723,618  | $ | 2,817,524    | $ | 906,094  
|2005                                                                                                                                                                                         |   |            |   |              |   |          
|Computer and office equipment                                                                                                                                                                | $ | 3,068,917  | $ | 2,191,882    | $ | 877,035  
|Leasehold improvements                                                                                                                                                                       |   | 507,386    |   | 360,204      |   | 147,182  
|                                                                                                                                                                                             | $ | 3,576,303  | $ | 2,552,086    | $ | 1,024,217
|                                                                                                                                                                                             |   |            |   |              |   |          
|Included in computer
    and office equipment are assets under capital lease totaling $509,648 (2005
    - $510,700) and related accumulated amortization of $421,139 (2005 
    $388,638).
|                                                                                                                                                                                             |   |            |   |              |   |          
|6. Intangible Assets                                                                                                                                                                         |   |            |   |              |   |          
|                                                                                                                                                                                             |   |            |   | Accumulated  |   | Net book 
|                                                                                                                                                                                             |   | Cost       |   | amortization |   | value    
|2006                                                                                                                                                                                         |   |            |   |              |   |          
|Patents                                                                                                                                                                                      | $ | 1,762,051  | $ | 626,309      | $ | 1,135,742
|Trademarks                                                                                                                                                                                   |   | 73,050     |   | 13,282       |   | 59,768   
|Customer agreements                                                                                                                                                                          |   | 193,182    |   | 84,298       |   | 108,884  
|Software development costs                                                                                                                                                                   |   | 10,875,561 |   | 8,758,238    |   | 2,117,323
|                                                                                                                                                                                             | $ | 12,903,844 | $ | 9,482,127    | $ | 3,421,717
|                                                                                                                                                                                             |   |            |   |              |   |          
|2005                                                                                                                                                                                         |   |            |   |              |   |          
|Patents                                                                                                                                                                                      | $ | 1,596,673  | $ | 451,616      | $ | 1,145,057
|Trademarks                                                                                                                                                                                   |   | 62,950     |   | 5,723        |   | 57,227   
|Customer agreements                                                                                                                                                                          |   | 166,473    |   | 36,321       |   | 130,152  
|Software development costs                                                                                                                                                                   |   | 9,581,903  |   | 7,688,288    |   | 1,893,615
|                                                                                                                                                                                             | $ | 11,407,999 | $ | 8,181,948    | $ | 3,226,051

-15-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

During 2006, $1,407,204 (2005 - $930,264) of software
development costs were deferred and are being amortized using the straight-line
method over a three-year economic life. Amortization for 2006 includes
$1,084,365 of amortization of deferred software development costs and $153,492,
$6,173 and $39,180, respectively, of amortization of patents, trademarks and
customer agreements. Amortization for 2005 includes $602,570 of amortization of
deferred software development costs and $150,102, $6,111 and $38,787,
respectively, of amortization of patents, trademarks and customer agreement. The
Company evaluated its other intangible assets at September 30, 2006 and
determined that no impairment had occurred.

The following is the estimated amortization expense of
intangible assets for each of the next five years:

|2007  | $ | 1,244,886
|----- | - | ---------
|2008  |   | 961,663  
|2009  |   | 462,073  
|2010  |   | 172,469  
|2011  |   | 172,469  
|Total | $ | 3,013,560

7. Bank Indebtedness and Notes Payable

On December 7, 2006, the Company entered into a Credit
Facility Agreement (the "Loan") with HSBC Bank Canada. Under the Loan Agreement,
the lender provided a demand loan of $1.0 million based on a single trade
receivable of the Companys insured by Export Development Canada with proceeds
assigned to the lender. The outstanding amount on the Loan is due on demand or
the earlier of the collection of the trade receivable or March 1, 2007. The
proceeds of the Loan were used to fund the short-term liquidity of the Company.
The obligation under the Loan are secured by a first priority interest in all
present and after acquired personal property of the Company and a floating
charge over all the Companys present and after acquired real property. The Loan
bears interest at LIBOR, plus 2 percent per annum - i.e., effective interest
rate of 7.37 percent per annum. The Loan Agreement contains a number of
restrictive covenants, all of which the Company was in compliance with as of
December 31, 2006. The Company repaid the Loan and accrued interest on January
12, 2007.

Through two subsidiaries of Archer, the Company held two
lines of credit as at December 31, 2005. Both lines of credit have a maximum
credit limit of $42,992, bear interest between prime and prime plus 1.3 percent,
were unsecured and payable upon demand. With the deconsolidation of Archer in
2006 both lines of credit were eliminated.

The note payable of $147,678 as of December 31, 2005
represents two notes payable of Archer to former shareholders in the amount of
$81,255 and $66,423. With the deconsolidation of Archer in 2006 the note payable
was eliminated.

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, 2006
were $1,833 (2005  $9,378). The current portion at December 31, 2006 was $1,833
(2005  $7,541). The future minimum lease payments under the capital leases are
$1,870 in 2007, not including lease interest of $37. No other payments are
required under the capital leases.

Inducements for leasehold improvements received by the
Company upon entering into new leases as at December 31, 2006 were $28,634 (2005
 $86,079). The current portion at December 31, 2006 was $28,634 (2005 
$57,386).

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. On July 16, 2006, the 290,200 outstanding stock purchase
warrants expired unexercised (December 31, 2005, 292,200 stock purchase warrants
were outstanding). As part of the consideration for services rendered by an
agent related to this private placement, the Company 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 were exercisable immediately
and expire if unexercised on July 16, 2006. Under the terms of the private
placement, the units sold in the private placement are subject to statutory
restrictions on resale, including hold periods. On July 16, 2006, the 68,182
outstanding stock purchase warrants expired unexercised (December 31, 2005,
68,182 stock purchase warrants were outstanding). The Company accounted for the
218,182 stock purchase warrants in accordance with SFAS No. 123 and recognized
common share issue costs of $141,048, calculated by using the Black-Scholes
option pricing model.

-16-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

On June 19, 2003, the Company completed a private placement
of 1,000,000 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. On May 31, 2006, the 495,000 outstanding stock purchase warrants
expired unexercised (December 31, 2005, 495,000 stock purchase warrants were
outstanding).

Stock-based compensation

Certain information regarding our stock-based compensation
was as follows:

|Weighted average grant-date per share
    fair value of share options granted | $ | 0.85     
|----------------------------------------------------------------------------- | - | ---------
|Fair value of non-vested shares that
    vested during the period             | $ | 1,353,356
|Stock-based compensation recognized in
    results of operations              | $ | 1,544,755
|Tax benefit recognized in statement of
    operations                         |   |         
|Cash received from options and RSUs
    exercised under stock option plans    |   |         
|Tax deduction realized related to
    stock options exercised                 |   |         

No material amount of stock-based compensation was
capitalized as a part of an asset during the year ended December 31, 2006.

The Company did not recognize a tax benefit from the
stock-based compensation expense because it is believed that it was more likely
than not that the related deferred tax assets, which have been reduced by a
valuation allowance, will not be realized.

The stock-based compensation expense included in the
Companys consolidated statement of loss was as follows:

|Selling general and administration     | $ | 1,208,701
|-------------------------------------- | - | ---------
|Product research and development       |   | 336,054  
|Total stock-based compensation expense | $ | 1,544,755

Compensation expense related to stock option and restricted
stock unit grants are based on the fair value of the underlying shares on the
date of grant as if the shares were vested. Compensation expense related to
options granted pursuant to our stock option plan was determined based on the
estimated fair values using the Black-Scholes Option Pricing Model and the
following weighted average assumptions:

|                        | 2006    
|----------------------- | --------
|Risk free interest rate | 3.9-4.2%
|Expected life in years  | 3.0     
|Expected dividend yield | 0%      
|Expected volatility     | 55-103% 
|Estimated Forfeiture    | 18.9%   

The risk-free interest rate used is based on the Canadian
benchmark bond yield expected term of the stock option. The expected dividend
yield is zero as the Company has not paid cash dividends in the past and has no
expectation of paying dividends in the foreseeable future. The expected term is
calculated using the vesting periods and is based on historical stock option
exercise patterns. Expected volatility is calculated based on applying
historical volatility over the expected life of the stock options granted.
Estimated forfeiture rates are based on the Companys historical experience.

-17-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

The Company recognizes stock-based compensation expense on a
straight-line basis over the vesting period of the individual award. The Company
issues new shares upon the exercise of stock options.

Stock option and restricted stock units

Since inception of the Stock Option Plan in 1993,
shareholders have approved resolutions reserving a total of 12,915,000 common
shares for issuance under the various plans of which 500,000 shares of the 1999
Plan are issuable as RSUs. The activity in the plans is as follows:

|Option Plans        | 1993      | 1995      | 1996      | 1998      | 1999      | Total     
|------------------- | --------- | --------- | --------- | --------- | --------- | ----------
|Shares authorized   | 2,625,000 | 1,430,000 | 2,600,000 | 1,300,000 | 4,960,000 | 12,915,000
|Granted             | 2,625,000 | 1,350,000 | 2,587,000 | 1,265,166 | 4,052,215 | 11,879,381
|Exercised           | 2,550,000 | 1,097,333 | 2,052,818 | 958,333   | 1,145,915 | 7,804,399 
|Cancelled           | 75,000    |           |           |           |           | 75,000    
|Outstanding         |           | 252,667   | 534,182   | 306,833   | 2,906,300 | 3,999,982 
|Available for Grant |           | 80,000    | 13,000    | 34,834    | 907,785   | 1,035,619 

Awards may be granted under the plans to employees, officers,
directors and consultants of the Company.

The plans are administered by the Board of Directors who has
the authority to designate participants, determine option prices and the vesting
schedules of each grant. To date, all options, except for RSUs, have been
granted at the fair market value of the stock at the date of grant with vesting
schedules ranging from immediate to three years. The options may in no event
have a term exceeding ten years from the date of grant. The stock options and
RSUs are not assignable. New common stock is issued upon exercise of stock
options or RSUs

In 2006, 87,468 (2005  nil) RSUs were granted and issued
without performance criteria attached and at no cost to the grantee. At December
31, 2006, 49,983 (2005  378,571) RSUs are outstanding. The RSUs 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 in
2006 of $156,663 (2005  $nil; 2004  $685,767 ) related to the RSUs, calculated
by using the fair value method.

A summary of option activity under the Plan as of December
31, 2006, 2005, and 2004, and changes during the years then ended is presented
below:

|                                                                                                     | 2006          | 2005           | 2004    
|---------------------------------------------------------------------------------------------------- | ------------- | -------------- | --------
|                                                                                                     | Shares        |                | Weighted
|                                                                                                     | under options |                | average 
|                                                                                                     | and RSUs      | exercise price | and RSUs
|Outstanding, beginning of
    year                                                                   | 4,106,487     | $              | 3.82    
|Granted                                                                                              | 1,580,468     |                | 1.41    
|RSUs Exercised                                                                                       | (416,056)     |                |        
|Options Exercised                                                                                    |              |                |        
|Forfeited or expired                                                                                 | (1,270,917)   |                | (6.25)  
|Outstanding, end of year                                                                             | 3,999,982     | $              | 2.49    
|Exercisable, end of year                                                                             | 3,595,483     | $              | 2.67    
|Weighted-average fair value of
    stock options and intrinsic value of RSUs granted during the year |               | $              | 0.85    

A summary of the status of the Companys unvested options as
of December 31, 2006, and changes during the year ended is December 31, 2006, is
presented below:

|                            | Shares 
    under options | Weighted 
    average fair-value 
    grant-date
|--------------------------- | ------------------------- | ------------------------------------------------
|Unvested, beginning of year | 116,166                   | $                                               
|Granted                     | 1,580,468                 |                                                 
|Forfeited or expired        | (187,583)                 |                                                 
|Vested                      | (1,104,552)               |                                                 
|Unvested, end of year       | 404,499                   | $                                               

-18-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

The following table summarizes the exercise price ranges of
outstanding and exercisable stock options as of December 31, 2006:

|                         | Total stock options and RSUs outstanding | Stock options and RSUs exercisable
|------------------------ | ---------------------------------------- | ----------------------------------
|                         |                                          | Weighted                          
|                         | Number outstanding                       | average remaining                 
|Range of exercise prices | December 31, 2006                        | contractual life                  
|$0.85  $1.72            | 457,982                                  | 4.58 years                        
|$1.73  $2.57            | 1,318,250                                | 3.64 years                        
|$2.58  $3.43            | 1,853,000                                | 2.01 years                        
|$3.44  $6.86            | 370,750                                  | 2.48 years                        
|$0.85  $6.86            | 3,999,982                                | 2.88 years                        

As of December 31, 2006, unrecognized stock-based
compensation related to outstanding, but unvested stock options was $122,472
which will be recognized over the weighted-average remaining vesting period of
1.64 years.

10. Equity Interest in Significantly Influenced Company

MLG ceased operations in July 2005 due to a substantial slow
down in operations, its inability to raise sufficient capital and successfully
market the companys product line. MLG has retained legal counsel to commence
voluntary liquidation and wind down procedures. The Company does not expect any
recovery of funds from this process and had previously provided for impairment
of amounts due from MLG. The Company holds a 40.4 percent interest in MLG,
received upon the disposition of Magic Vision Media on November 7, 2002. At
December 31, 2006, the Company held 29,750,000 shares of MLG with a par value of
$0.01 per share and a fair market value of nil. The Companys proportionate
share of the loss from MLG operations for year ended December 31, 2006, 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 December 31, 2004 is
$7,445,161. The Company is unable to report a more recent unrecorded share of
the loss as MLG has not provided a more recent financial position.

In April 2005, the Company advanced $250,000 under a secured
loan agreement to MLG, which has been provided for (see note 12).

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 the operating
results of each subsidiary and the parent company. The components of income
(loss) before income tax expenses are as follows:

|                                                         |   | 2006        |   | 2005        |   | 2004       
|-------------------------------------------------------- | - | ----------- | - | ----------- | - | -----------
|Restated See note 3 & 21                                 |   |             |   |             |   |            
|Canadian Operations                                      | $ | (6,905,920) | $ | (8,931,199) | $ | (5,723,479)
|International Operations                                 |   | (1,958,589) |   | 5,129,794   |   | 4,052,115  
|                                                         | $ | (8,864,509) | $ | (3,801,405) | $ | (1,671,364)
|                                                         |   |             |   |             |   |            
|The Components of income tax
    expense are as follows:
|                                                         |   | 2006        |   | 2005        |   | 2004       
|Restated See note 3 & 21                                 |   |             |   |             |   |            
|Canadian Operations                                      | $ | -           | $ | -           | $ |           
|International Operations                                 | $ | 885,084     | $ | 687,515     | $ | 336,161    

-19-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

The provision for income taxes reflects an effective tax rate that differs
from the corporate tax rate for the following reasons:

|Restated See note 3 & 21                                                                |   | 2006         |   | 2005         |   | 2004        
|--------------------------------------------------------------------------------------- | - | ------------ | - | ------------ | - | ------------
|                                                                                        |   |              |   |              |   |             
|Combined basic federal and provincial
    income tax rate                               |   | 33.40%       |   | 33.62%       |   | 36.60%      
|Expected combined
    Canadian federal and provincial tax recovery based on above rates | $ | (3,268,251)  | $ | (1,278,032)  | $ | (611,719)   
|Enacted tax rate
    adjustment differences                                             |   | 104,426      |   |             |   | 188,281     
|Differences in foreign
    statutory tax rates                                          |   | 373,247      |   | 459,992      |   | 149,344     
|Permanent differences                                                                   |   | 1,440,996    |   | 218,924      |   | 618,560     
|Equity in net loss of
    significantly influenced company                              |   |             |   |             |   |            
|Loss on dissolution of
    subsidiaries                                                 |   |             |   |             |   | 1,159,877   
|Impairment of note
    receivable                                                       |   | 22,648       |   | 84,050       |   | 677,400     
|Unrecognized
    recoveries on losses                                                   |   |             |   |             |   | (2,026,023) 
|Scientific research
    and experimental development                                    |   | (275,614)    |   | (289,080)    |   |            
|Prior expenses charged
    to current year                                              |   | (108,254)    |   | (117,659)    |   |            
|2004 PRC tax paid in
    2005                                                           |   |             |   |             |   |            
|2005 PRC tax paid in
    2006                                                           |   | (68,091)     |   |             |   |            
|Tax exemption                                                                           |   | 161,635      |   |             |   |            
|Other                                                                                   |   | (56,736)     |   | 256,037      |   | 320,811     
|Valuation allowance                                                                     |   | 2,559,078    |   | 1,353,283    |   | (140,370)   
|Consolidated income tax                                                                 | $ | 885,084      | $ | 687,515      | $ | 336,161     
|                                                                                        |   |              |   |              |   |             
|The components of
    future income taxes are as follows:                               |   |              |   |              |   |             
|December 31,                                                                            |   | 2006         |   | 2005         |   | 2004        
|Restated See note 3 &
    21                                                            |   |              |   |              |   |             
|Capital assets                                                                          | $ | 268,247      | $ | 201,201      | $ | 102,294     
|Software development
    costs                                                          |   | (680,084)    |   | (636,633)    |   | (496,898)   
|Deferred revenue                                                                        |   | (102,014)    |   | 322,027      |   |            
|Share issue costs                                                                       |   | 84,767       |   | 134,727      |   | 181,667     
|Other                                                                                   |   | (337,855)    |   | 47,203       |   | 73,892      
|Loss carry forwards                                                                     |   | 19,006,279   |   | 17,843,312   |   | 16,960,182  
|Valuation allowance                                                                     |   | (18,413,740) |   | (17,911,837) |   | (17,026,185)
|Net future income tax liability                                                         | $ | (174,400)    | $ |             | $ | (205,048)   

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.

According to PRC tax law, those FIE established in China that
are involved in "productive" activities are entitled to tax holidays and tax
reductions. These FIE tax benefits include a two-year tax holiday followed by a
50 percent reduction of the otherwise applicable tax rate for the following
three years. Our Zi Technology subsidiary Huayu Zi was categorized as a
productive-type FIE in all its PRC statutory filings, including its routine
filings to tax authorities.

In 2005, PRC tax authorities tightened the scope of FIE tax
incentives and narrowed the tax-free/reduction entitlement to only those who are
engaged in productive activities or are engaged in "encouraged" industries.
Recent changes to the operations of Huayu Zi resulted in decreases to its
research and development activities and revenues generated from productive
activities (as defined under the FIE guidelines) are below the stipulated levels
now required to qualify as a FIE eligible for the tax holidays and reductions.
As a result, Huayu Zi does not qualify as a productive type FIE and is not
eligible for the tax holidays and tax reductions. Huayu Zi made provision for
income taxes payable as a result of no longer having prior years tax losses
available and the uncertainty associated with qualifying for statutory tax
relief of $549,048, $556,402 and $131,113 for the years ended December 31, 2006,
2005 and 2004, respectively.

-20-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

At December 31, 2006, the Companys Canadian subsidiaries
have non-capital losses of $30,764,641, which expire between 2007 and 2014 and
net capital losses of $50,850,864, which do not expire and are available to
reduce Canadian taxable capital gains in future years. The Company has foreign
non-capital losses of $45,017,896 of which $38,295,746 does not expire and the
balance of $6,722,150 relate to our US subsidiary and expire between 2110 and
2026.

12. Impairment of note receivable.

Archer (see note 21) was incorporated in February 2005 for
the purpose of acquiring a number of educational learning institutions in
Canada. Zi acquired 24.9 percent of Archers shares, through share subscription
agreements in 2005. Consequently, Zi is a related party to Archer. The Companys
ownership of Archer increased primarily by the sale of its Oztime and EPI
subsidiaries to Archer. Under the sale agreements, Zi received 6,140,000 shares
of Archer, including contingent consideration of 1,000,000 shares placed in
escrow and a RMB 1,000,000 non-interest bearing note receivable  December 31,
2006, U.S. dollar equivalent of $129,417. At December 31, 2006, 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, the full amount of the note receivable was impaired
and hence provided for. At the time of the impairment, Archer had been
unsuccessful in raising additional capital sufficient enough to repay the note
and continued to post operating losses. Due to these factors it was probable
that Archer would not have the necessary funds available to meet the
requirements under the note.

On November 7, 2002, the Company completed the sale of Magic
Vision Media, parent of Magic Lantern Communications Ltd. (collectively, "Magic
Lantern") to JKC Group Inc. ("JKC"), a related party (note 14) and an American
Stock Exchange listed company incorporated in the state of New York. Magic
Lantern operations comprised 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 MLG. Under the agreement, as part of the sale
consideration, Zi received a three-year promissory note from MLG in the amount
of $3,000,000, bearing interest at the rate of 5 percent per annum, due in full
November 7, 2005. The note was subject to adjustment based on MLGs financial
performance during the first year after the sale. The performance criteria
stipulated under the agreement were not met. The purchase price was reduced by
$1,000,000, offset against the principal amount of the MLG promissory note
reducing it to $2,000,000.

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 hence provided for.
At the time of the impairment, MLG was under a going concern qualification and
subject to ongoing operating cash requirements, continued operating losses and
other debt to which the Company is subordinate. Due to those factors and the
absence of private placements originally anticipated by MLG to occur in the
fourth quarter of 2004, it was probable that MLG would 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.

In April 2005, the Company advanced $250,000 under a secured
loan agreement to MLG. The terms of the agreement required repayment on demand
and provided the Company with a security interest in the assets of MLG. At June
30, 2005, 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 hence provided for. At the time of the impairment, MLG was
under a going concern qualification and subject to ongoing operating cash
requirements, continued operating losses and other debt to which the Company is
subordinate. Due to these factors and the directive by Zis Board of Directors
to not provide further funding to MLG, it was probable that MLG would 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.

To the best of the Companys knowledge, MLG ceased all
operations in July 2005 and is undertaking a voluntary dissolution and windup
(See note 10). All amounts have been written off the Companys accounts as of
December 31, 2005.

13. Contingent Liabilities

The Company is subject to income taxes in Canada and other
foreign jurisdictions. Significant judgment is required in determining our
worldwide provision for income taxes and recording the related assets and
liabilities. The Company international transfer pricing policies and procedures
and documentation is currently under audit by Canada Revenue Agency. The audit
is still on going. The ultimate resolution of this matter is uncertain and the
range of possible outcomes has not been determined by the Company. Accordingly,
the Company has not recorded any liability relating to this audit as of December
31, 2006. The Company will continue to monitor the progress of the audit and
assess if potential liability is likely.

Commencing on March 11, 2005, the Board of Regents of the
University of Texas System ("UT") filed federal lawsuits against numerous
alleged infringers of U.S. Patent No. 4,674,112 ("112 Patent") in the U.S.
District Court for the Western District of Texas, Austin Division. Of the named
parties, the majority are customers of the Companys principal competitor in the
text input market and a few are customers of the Company.

-21-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

The Company is not a named party in the action. The Company
has not accepted liability for any indemnity pursuant to its customer license
agreements or otherwise. As a result of the Company's efforts the claim against
two of the Companys customers was dismissed prior to any defence being filed.
Without any admission of liability, the Company agreed as a business decision to
assume the defence of five of its customers. Given the costs involved, the
Company settled the claims against four of the Companys relatively minor
customers.

On May 2, 2007, the United States District Court for Western
District of Texas issued an Order of Non-Infringement of US Patent No. 4,674,112
against the Plaintiff, The Board of Regents of the University of Texas, and in
favor of all remaining Defendants. The plaintiff has filed an appeal within the
statutory 30 day limit for filing the appeal.

On February 22, 2007, the Company entered into a settlement
agreement with the Receiver for the Lancer Fund (the "Receiver") to settle any
and all outstanding claims and issues between the Receiver, the Lancer Entities
and the Company. The settlement is conditioned upon the Receiver securing orders
from the United States District Court for the Southern District of Florida and
the United States Bankruptcy Court for the Southern District of Florida,
authorizing the Receiver to execute the Settlement Agreement on behalf of the
Lancer Entities. The settlement is also conditioned upon the parties securing
the acknowledgement of the Alberta Securities Commission ("ASC") that the ASC
will dismiss with prejudice Zi's pending action against the Receiver; that the
ASC has no objection to the parties terminating such pending action; and that
the ASC will take no further action based on acts of Michael Lauer and others
which preceded the Receivers appointment.

On April 10, 2007, a settlement agreement with the Receiver
for the Lancer Entities became fully effective. Pursuant to the settlement
agreement, the Receiver and the Company agreed to, among other things,
immediately discontinue, with prejudice, all litigation and regulatory
proceedings of any kind. In addition, the Receiver, the Company and certain
current and former directors of the Company have agreed to deliver mutual
releases. As a result of the settlement agreement, Michael E. Lobsinger has
resigned as a director of the Company. He is replaced as a director by George
Tai of Calgary, Alberta.

On November 18, 2005, the former President and Chief
Executive Officer of the Company filed a wrongful termination lawsuit against
the Company in the Court of Queens Bench of Alberta, Judicial District of
Calgary. The Plaintiff was the President and CEO of Zi for the period from July
23, 2003 to May 26, 2005, when he submitted his resignation. On December 9,
2005, the Company filed its Statement of Defense and Counterclaim, denying the
Plaintiffs claims. In March 2006, the Company settled these actions. The
Company had accrued sufficient settlement costs related to this lawsuit as of
December 31, 2005.

On December 4, 2003, the Company commenced a legal action
against former counsel in respect of, among other things, their representation
of the Company in a lawsuit, the outcome of which was unfavorable to the
Company. As part of its defense, prior counsel filed a cross complaint against
the Company for $1.1 million in unpaid legal fees and costs, which has been
accrued by the Company in its financial statements. On April 6, 2005, the
Company settled this litigation. The Company recorded a gain of $1,415,616 in
the three month period ended June 30, 2005.

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.

14. Related Party Transactions

The following table outlines the Companys related party
transactions for the years ending December 31:

|                                                                           |   | 2006    |   | 2005    |   | 2004   
|-------------------------------------------------------------------------- | - | ------- | - | ------- | - | -------
|Legal services provided by a law firm in
    which a director is a partner | $ | 158,078 | $ | 227,883 | $ | 125,708
|Fees paid on behalf of a significantly
    influenced company              | $ | 7,247   | $ | 760     | $ | 10,442 
|Management fees paid to a firm owned by a
    director                     | $ |        | $ |        | $ | 30,000 
|Consulting fees paid to a firm in which an
    officer is a partner        | $ | 66,006  | $ |        | $ |       
|Consulting fees paid to a firm owned by a
    former officer               | $ | 34,248  | $ | 49,333  | $ | 46,067 

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.

In April 2005, the Company advanced $250,000 under a
secured loan agreement to MLG. At June 30, 2005, the full amount of the note
receivable including accrued interest was impaired and hence provided for (see
note 12).

At year-end, the amounts due from (to) related parties are as
follows:

|                                                     |   | 2006     |   | 2005     |   | 2004   
|---------------------------------------------------- | - | -------- | - | -------- | - | -------
|Due to law firm in
    which a director is a partner | $ | (57,931) | $ | (47,388) | $ | (5,338)

|Due from significantly
    influenced company         | $ |         | $ |  | $ | 43,629
|----------------------------------------------------- | - | -------- | - | - | - | ------
|Due to a company in
    which an officer is a partner | $ | (56,188) | $ |  | $ |      

-22-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

15. Commitments and Guarantees

The Company rents premises and equipment under operating
leases, which expire at various dates up to June 2012. The Company recorded rent
expense for 2006 of $641,113 (2005  $573,516, 2004  $480,575).

Annual rentals under these leases for each of the next five
years are as follows:

|2007  | $ | 714,105  
|----- | - | ---------
|2008  |   | 588,022  
|2009  |   | 536,423  
|2010  |   | 536,423  
|2011  |   | 536,423  
|Total | $ | 2,911,396

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. 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.

16. Segmented Information

Zi develops software designed to enhance the usability of
mobile and consumer electronic devices through its Zi Technology business
segment. Zi has a singular focus: to make mobile devices smarter and easier to
use. Zi makes "intelligent interfaces" - software products that simplify data
entry and interaction on communications devices. The result is richer, more
personalized interaction for quicker, easier communication in 60 different
language databases for use around the world.

Zi's product portfolio includes five products. eZiTap
combines the power of predictive texting and automatic vocabulary learning with
the familiarity and flexibility of multi-tap input. eZiTap is ideal for the
youth market in which multi-tap is used to create unique and fun vocabulary and
texting shortcuts. eZiType is a comprehensive predictive text entry product for
mobile email users. Ideal for keyboard-based mobile devices such as smartphones,
PDAs and gaming consoles, eZiType improves the mobile email user's text entry
experience by enhancing typing speed and spelling accuracy. eZiText provides
fast, efficient, predictive one-touch entry and word completion, enhanced with
the interactive learning and personalization of a user's own language patterns
and behavior. Qix is a new service discovery engine that 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 the
traditionally structured menu system. Decuma is a new interactive handwriting
input product from Zi that mimics how humans write with pen on paper - naturally
and efficiently - in a broad range of languages. Revenues are reported under the
contracting Zi subsidiarys country of residence.

Corporate includes unallocated segment expenses such as legal
fees, public company costs and head office costs. The accounting policies of
each of the business segments are the same as those described in note 3.

The Companys primary operations are located in North
America. The Company operates three reportable business segments in four
reportable geographic segments:

|                                               | Revenue              |            |       |              |     |            |                 
|---------------------------------------------- | -------------------- | ---------- | ----- | ------------ | --- | ---------- | ----------------
|                                               |                      |            |       |              |     |            |                 
|                                               | Royalty, license and | Other      |       |              |     |            |                 
|                                               | implementation fees  | product    | Total | Amortization | VAT | expenses   | and other income
|2006                                           |                      |            |       |              |     |            |                 
|Zi Technology                                  | $                    | 11,836,217 | $     |             | $   | 11,836,217 | $               
|Corporate                                      |                      |           |       |             |     |           |                 
|Total                                          | $                    | 11,836,217 | $     |             | $   | 11,836,217 | $               
|Interest expense and interest and other income |                      |            |       |              |     |            |                 
|Loss before income taxes                       |                      |            |       |              |     |            |                 

-23-

---



> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

|2005                                               |   |            |      |           |   |            |   |              |        |           |         |            |        |             
|-------------------------------------------------- | - | ---------- | ---- | --------- | - | ---------- | - | ------------ | ------ | --------- | ------- | ---------- | ------ | ------------
|Zi Technology                                      | $ | 10,614,043 | $    |          | $ | 10,614,043 | $ | 975,867      | $      | 522,278   | $       | 11,603,694 | $      | (2,487,796) 
|Corporate                                          |   |           |      |          |   |           |   | 176,427      |        |          |         | 1,455,940  |        | (1,632,367) 
|Total                                              | $ | 10,614,043 | $    |          | $ | 10,614,043 | $ | 1,152,294    | $      | 522,278   | $       | 13,059,634 | $      | (4,120,163) 
|Interest expense and interest and
    other income |   |            |      |           |   |            |   |              |        |           | 318,758
|Loss before income taxes                           |   |            |      |           |   |            |   |              |        |           |         |            | $      | (3,801,405) 
|                                                   |   |            |      |           |   |            |   |              |        |           |         |            |        |             
|2004                                               |   |            |      |           |   |            |   |              |        |           |         |            |        |             
|Zi Technology                                      | $ | 12,898,838 | $    |          | $ | 12,898,838 | $ | 709,064      | $      | 434,386   | $       | 9,480,805  | $      | 2,274,583   
|Corporate                                          |   |           |      |          |   |           |   | 193,176      |        |          |         | 3,798,053  |        | (3,991,229) 
|Total                                              | $ | 12,898,838 | $    |          | $ | 12,898,838 | $ | 902,240      | $      | 434,386   | $       | 11,278,858 | $      | (1,716,646) 
|Interest expense and interest and
    other income |   |            |      |           |   |            |   |              |        |           | 45,282 
|Gain before income taxes                           |   |            |      |           |   |            |   |              |        |           |         |            | $      | (1,671,364) 
|                                                   |   |            |      |           |   |            |   |              |        |           |         |            |        |             
|                                                   |   |            |      |           |   |            |   |              |        |           |         |            |        |             
|                                                   |   |            | 2006 | 2005     
|                                                   |   |            |      | Capital   |   | Other      |   | Identifiable |        | Capital   |         | Other      |        | Identifiable
|                                                   |   |            |      | assets    |   | assets     |   | assets       | assets |           | assets  |            | assets
|Zi Technology                                      |   |            | $    | 4,094,355 | $ | 9,520,898  | $ | 13,615,253   | $      | 3,855,682 | $       | 6,036,311  | $      | 9,891,993   
|Corporate                                          |   |            |      | 233,456   |   | 698,361    |   | 931,817      |        | 394,586   |         | 9,880,435  |        | 10,275,021  
|Total                                              |   |            | $    | 4,327,811 | $ | 10,219,259 | $ | 14,547,070   | $      | 4,250,268 | $       | 15,916,746 | $      | 20,167,014  

Corporate includes non-cash compensation expense related to
issuance of employee stock options and RSUs in 2006 of $1,497,369 (2005  nil;
2004  $685,631). All additions to software development costs of $1,407,204 in
2006 (2005  $930,264) are part of Zi Technology operations.

|                                                   | Revenue |                                          |               |   |       |            |              |           | Operating profit (loss) before interest and other income
|-------------------------------------------------- | ------- | ---------------------------------------- | ------------- | - | ----- | ---------- | ------------ | --------- | --------------------------------------------------------
|                                                   |         | Royalty, license and implementation fees |               |   |       |            |              |           |                                                         
|                                                   |         |                                          | Other product |   | Total |            | Amortization |           | VAT                                                     
|                                                   |         |                                          |               |   |       |            |             
|                                                   |         |                                          |               |   |       |            |             
|                                                   |         |                                          |               |   |       |            |             
|2006                                               |         |                                          |               |   |       |            |              |           |                                                         
|Canada                                             | $       | 5,832,869                                | $             |  | $     | 5,832,869  | $            | 1,417,331 | $                                                       
|China                                              |         | 4,751,684                                |               |  |       | 4,751,684  |              | 99,719    |                                                         
|U.S.A.                                             |         | 935,956                                  |               |  |       | 935,956    |              | 6,606     |                                                         
|Sweden                                             |         | 315,708                                  |               |  |       | 315,708    |              | 169,160   |                                                         
|Other                                              |         |                                         |               |  |       |           |              | 14,396    |                                                         
|Total                                              | $       | 11,836,217                               | $             |  | $     | 11,836,217 | $            | 1,707,212 | $                                                       
|Interest expense and interest and
    other income |         |                                          |               |   |       |            |              |           |                                                         
|Impairment of note receivable                      |         |                                          |               |   |       |            |              |           |                                                         
|Loss before income taxes                           |         |                                          |               |   |       |            |              |           |                                                         

-24-

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> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

|                                               |   |            |      |                |   |              |   |              |                |              |         |            |   |             
|---------------------------------------------- | - | ---------- | ---- | -------------- | - | ------------ | - | ------------ | -------------- | ------------ | ------- | ---------- | - | ------------
|2005                                           |   |            |      |                |   |              |   |              |                |              |         |            |   |             
|Canada                                         | $ | 4,175,334  | $    |               | $ | 4,175,334    | $ | 905,639      | $              |             | $       | 6,801,134  | $ | (3,531,439) 
|China                                          |   | 5,019,599  |      |               |   | 5,019,599    |   | 53,971       |                | 522,278      |         | 2,739,411  |   | 1,703,939   
|U.S.A.                                         |   | 1,021,769  |      |               |   | 1,021,769    |   | 14,246       |                |             |         | 2,024,754  |   | (1,017,231) 
|Sweden                                         |   | 397,341    |      |               |   | 397,341      |   | 164,042      |                |             |         | 1,406,772  |   | (1,173,473) 
|Other                                          |   |           |      |               |   |             |   | 14,396       |                |             |         | 87,563     |   | (101,959)   
|Total                                          | $ | 10,614,043 | $    |               | $ | 11,384,513   | $ | 1,152,294    | $              | 522,278      | $       | 13,059,634 | $ | (4,120,163) 
|Interest expense and interest and other income |   |            |      |                |   |              |   |              |                |              | 318,758
|Loss before income taxes                       |   |            |      |                |   |              |   |              |                |              |         |            | $ | (3,801,405) 
|                                               |   |            |      |                |   |              |   |              |                |              |         |            |   |             
|2004                                           |   |            |      |                |   |              |   |              |                |              |         |            |   |             
|Canada                                         | $ | 5,884,396  | $    |               | $ | 5,884,396    | $ | 784,577      | $              |             | $       | 9,072,948  | $ | (3,973,129) 
|China                                          |   | 5,207,579  |      |               |   | 5,207,579    |   | 87,586       |                | 434,386      |         | 2,227,742  |   | 2,457,865   
|U.S.A.                                         |   | 1,806,863  |      |               |   | 1,806,863    |   | 15,681       |                |             |         | 1,868,755  |   | (77,573)    
|Other                                          |   |           |      |               |   |             |   | 14,396       |                |             |         | 109,413    |   | (123,809)   
|Total                                          | $ | 12,898,838 | $    |               | $ | 12,898,838   | $ | 902,240      | $              | 434,386      | $       | 11,278,858 | $ | (1,716,646) 
|Interest expense and interest and other income |   |            |      |                |   |              |   |              |                |              | 45,282 
|Loss before income taxes                       |   |            |      |                |   |              |   |              |                |              |         |            | $ | (1,671,364) 
|                                               |   |            |      |                |   |              |   |              |                |              |         |            |   |             
|                                               |   |            |      |                |   |              |   |              |                |              |         |            |   |             
|                                               |   |            | 2006 | 2005          
|                                               |   |            |      |                |   |              |   | Identifiable |                |              |         |            |   | Identifiable
|                                               |   |            |      | Capital assets |   | Other assets |   | assets       | Capital assets | Other assets |         | assets    
|Canada                                         |   |            | $    | 2,803,787      | $ | 4,637,029    | $ | 7,440,816    | $              | 2,775,140    | $       | 10,442,969 | $ | 13,218,109  
|China                                          |   |            |      | 192,608        |   | 5,059,157    |   | 5,251,765    |                | 162,607      |         | 4,341782   |   | 4,504,389   
|U.S.A                                          |   |            |      | 23,193         |   | 246,866      |   | 270,059      |                | 26,860       |         | 535,127    |   | 561,987     
|Sweden                                         |   |            |      | 1,229,044      |   | 258,745      |   | 1,487,789    |                | 1,192,086    |         | 579,669    |   | 1,771,755   
|Other                                          |   |            |      | 79,179         |   | 17,462       |   | 96,641       |                | 93,575       |         | 17,199     |   | 110,774     
|Total                                          |   |            |      | 4,327,811      |   | 10,219,259   |   | 14,547,070   | $              | 4,250,268    | $       | 15,916,746 | $ | 20,167,014  

Canada includes non-cash compensation expense related to
issuance of employee stock options and RSUs in 2006 of $1,497,369 (2005  nil;
2004  $685,631). All additions to software development costs of $1,407,204 in
2006 (2005  $930,264) are part of Canadian operations.

17. Supplemental Financial Information

Accrued liabilities

The following items are included in the accounts payable and
accrued liabilities balance:

|Accounts payable and
    accrued liabilities |   | 2006      |                         | 2005     
|-------------------------------------------- | - | --------- | ----------------------- | ---------
|                                             |   |           | (restated  see note 3)
|Compensation                                 | $ | 1,285,652 | $                       | 1,275,824
|Trade accounts payable                       |   | 1,174,585 |                         | 561,808  
|Withholding tax and
    income taxes payable |   | 876,546   |                         | 1,058,127
|Accounting and other
    compliance          |   | 315,641   |                         | 311,251  
|Litigation and legal                         |   | 327,048   |                         | 255,866  
|Other accrued liabilities                    |   | 66,550    |                         | 77,000   
|Total                                        | $ | 4,046,022 | $                       | 3,539,876

-25-

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> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

Loss per share

In 2006, anti-dilutive stock options, RSUs, warrants and
performance based escrowed shares of 3,999,982 have been excluded in the
calculation of diluted loss per share (2005  4,959,869; 2004  6,374,836).

18. Governmental Regulation

Archer (see note 21) and each learning institution are
subject to regulation by federal and provincial governmental agencies and
accrediting bodies. In order to participate in the various provincial student
financial assistance programs, the schools must satisfy regulatory scrutiny on
the basis of numerous standards as well as demonstrate their compliance to the
governmental bodies on an ongoing basis. As of December 31, 2005, Archers
institutions were in compliance with the applicable regulations in all material
respects.

All institutions participating in the provincial student
assistance programs must satisfy specific standards of financial responsibility.
The provincial governmental bodies evaluate the institutions for compliance with
these standards each year, based on the institutions audited financial
statements.

Because Archer operates in a regulated industry, it may be
subject to, from time to time, investigations, claims of non-compliance, or
lawsuits by governmental agencies or third parties, which allege statutory
violations, regulatory infractions, or common law causes of action. There can be
no assurance that other regulatory agencies or third parties will not undertake
investigations or make claims against the Archer, or that such claims, if made,
will not have a material adverse effect on Archers business results of
operations or financial condition.

19. Economic Dependence

In 2006, two Zi Technology customers accounted for 34 percent
or $4,311,634 (2005  31 percent or $3,583,403; 2004  34 percent or $4,587,871)
of the Companys total revenue. As at December 31, 2006, the Companys single
largest customer accounted for 52% of the accounts receivable balance.
Subsequent to year-end, the full amount of the receivable was collected.

20. Subsequent Events

Private Placement

On March 29, 2007, the Company completed a brokered private
placement in the United States and a non-brokered private placement in Canada of
a total of 3,776,848 units priced at $1.61 per unit for gross proceeds of
$6,000,712. Each unit consists of one share of the Companys stock and two-fifth
of a stock purchase warrant. Each whole stock purchase warrant is exercisable
into one share of the Companys stock after six months from the date of closing
but before March 29, 2012, at an exercise price of $2.14 per share. As for fees
for services, the Company agreed to pay a commission to the placement agent
involved in the private placement in the United States equal to eight percent of
the gross proceeds of such private placement, with six percent to be paid in the
form of cash and two percent to be paid in the form of units, which have been
included in the total units above, equal to the price paid per unit. An
additional eight percent will be paid on the gross proceeds on the exercise of
any share purchase warrants held by investors during the first twelve months
following the closing of the private placement in the United States and four
percent of the gross proceeds on the exercise of any share purchase warrants
held by investors during the second twelve months following the closing of the
private placement in the United States. Such placement agent will also be issued
warrants to purchase such number of common shares of the Company equal to eight
percent of the units issued in the private placement in the United States. Under
the terms of the private placement, the units sold in the private placement are
subject to statutory restrictions on resale, including hold periods.

Stock Option Grant

On January 10, 2007, the Company granted to directors 250,000
stock options with a fair value of $0.82 per share option under the Companys
stock option plans. The value of those shares options, aggregating $205,000 will
be amortized over the 12-month vesting period. On January 10, 2007, the Company
granted to employees other than senior management and directors 72,000 stock
options with a fair value of $0.64 per share option under the Companys stock
option plans. The value of those share options, aggregating $46,080, will be
amortized over the three-year vesting period.

On February 28, 2007, the Company granted to an officer and
director 400,000 stock options with a fair value of $1.00 per share option under
the Companys stock option plans. The value of those share option, aggregating
$400,000 will be amortized over the three-year vesting period.

21. Discontinued Operations

On March 12, 2007, the Zi received an offer to purchase its
minority interest in Archer. The offer was presented and approved by the
Companys Board of Directors on March 22, 2007. Effective March 27, 2007, the
Company sold its minority interest in Archer for CDN$0.12 per share for total
proceeds of CDN$736,800. There were no contingent considerations, or performance
criteria in the sale agreement.

-26-

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> Notes to the Consolidated Financial
>   StatementsFor the years ended December 31,
>   2006, 2005 and 2004 (All amounts expressed in United States of America dollars
>   except share amounts)

Because the Companys management had not previously been
given a mandate by the Board of Directors to locate a purchaser of its
investment in Archer, Archer was initially included in the Companys
consolidated operating loss for all previous periods. For the years ended March
31, 2006, 2005, and 2004, Archers operating results have been reclassified to
discontinued operations, net of taxes (see note 11) and disclosures elsewhere to
conform with this change.

|For the year ended December 31                                          |   | 2006      |   | 2005        |   | 2004       
|----------------------------------------------------------------------- | - | --------- | - | ----------- | - | -----------
|Revenue                                                                 | $ | 555,523   | $ | 770,470     | $ | 504,213    
|Cost of sales                                                           |   | (22,696)  |   | (248,689)   |   | (109,252)  
|Operating expenses                                                      |   | (893,177) |   | (1,368,110) |   | (1,138,667)
|Interest income                                                         |   | 9,032     |   | 41,746      |   | 26,871     
|Non-controlling
    interest                                            |   | -         |   | (23,920)    |   | -          
|Equity Interest loss in Archer (March
    1, 2006 to December 31, 2006) |   | (893,973) |   | -           |   | -          
|Net loss                                                                | $ | 1,245,291 | $ | 828,503     | $ | 716,835    

Prior to the completion of the sale, Archers operating
results had been categorized as the Companys e-Learning business segment (see
Note 16).

Prior to 2005, Zi conducted its e-Learning business segment
through Oztime Education & Network Technology Co. Ltd. ("Oz") and English
Practice Inc. ("EPI"). Archer was incorporated in February 2005 for the purpose
of acquiring Oz and EPI and continuing the e-Learning Business Segment.
Effective March 1, 2006, Archer was deconsolidated and accounted for under the
equity method. See note 4 "Acquisition of Archer Education Group Inc."

The Company has recognized its proportionate share of the
loss of Archer operations for the period between March 1, 2006 and December 31,
2006, in the amount of $893,973, and appropriately reduced its investment in
Archer by the same amount. As at December 31, 2006, the Company held 6,140,000
shares of Archer. Archer is a private company and as such the Company is unable
to determine a fair value for this investment. As at December 31, 2006, equity
in net loss of Archer had exceeded Zis investment in Archer. The Company does
not recognize its proportionate share of losses that would result in a negative
carrying value of its equity investment. No further losses will be recognized as
Zi has no commitment to fund further losses. As a result, the full amount of the
proceeds were recognized as a gain on disposal of discontinued operations in the
period ended March 31, 2007.

As the Company disposed of Archer on March 27, 2007, for the
consolidated balance sheets as at March 31, 2006, and 2005, Archers assets and
liabilities have been reclassified to discontinued operations. Archers assets
and liabilities consist of the following:

|As at December 31                            |   | 2006 |   | 2005     
|-------------------------------------------- | - | ---- | - | ---------
|Cash and cash equivalents                    | $ | -    | $ | 730,004  
|Accounts receivable                          |   | -    |   | 649,269  
|Work-in-process and inventory                |   | -    |   | 13,897   
|Prepayments and deposits                     |   | -    |   | 48,762   
|Capital assets - net                         |   | -    |   | 186,730  
|Ministry registration and assistant programs |   | -    |   | 135,742  
|Curriculum                                   |   | -    |   | 134,590  
|Contracts relationship                       |   | -    |   | 338,497  
|Total Assets                                 | $ | -    | $ | 2,237,491
|                                             |   |      |   |          
|As at December 31                            |   | 2006 |   | 2005     
|Bank indebtedness                            | $ | -    | $ | 106,650  
|Accounts payable and accrued liabilities     |   | -    |   | 1,007,849
|Deferred Revenue                             |   | -    |   | 462,090  
|Notes payable                                |   | -    |   | 147,678  
|Total Liabilities                            | $ | -    | $ | 1,724,267

-27-

---

As Archer was deconsolidated on March 1, 2006 and Zis equity interest in
Archer was written down to nil value as at December 31, 2006, no assets or
liabilities are applicable as at December 31, 2006.









-28-

---

REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTSTo the Board of Directors and Shareholders of
Zi Corporation
We have audited the consolidated financial
statements of Zi Corporation (the ''Company'') as of December 31, 2006 and 2005,
and for each of the three years in the period ended December 31, 2006, and have
issued our reports thereon dated March 29, 2007 (which audit report expresses an
unqualified opinion and includes an explanatory paragraph referring to our
consideration of internal control over financial reporting and also includes a
separate report titled "Comments by Independent Registered Chartered Accountants
on Canada  United States of America Reporting Differences" referring to changes
in accounting principles that have a material effect on the comparability of the
Companys financial statements); such financial statements and reports are
included in the 2006 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, presents fairly, in all material respects, the
information set forth therein.
(signed) "Deloitte & Touche LLP"
Independent Registered Chartered Accountants

Calgary, Alberta, Canada 
March 29, 2007Schedule 11 - Valuation and Qualifying Accounts

|                                | Balance at   |                  |            |            
|------------------------------- | ------------ | ---------------- | ---------- | -----------
|                                | Beginning of | Charged to costs |            | Balance at 
|                                | Year         | and expenses     | Deductions | End of Year
|Allowance for Doubtful Accounts |              |                  |            |            
|Year Ended December 31, 2006    | $ 426,697    | $ 750,535        | $ 240,501  | $ 936,731  
|Year Ended December 31, 2005    | $ 154,108    | $ 278,589        | $ 6,000    | $ 426,697  
|Year Ended December 31, 2004    | $ 507,640    | $ 68,844         | $ 422,376  | $ 154,108  



-29-

---