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

FORM 20-F

|(Mark One)                                                                                     
|-----------------------------------------------------------------------------------------------
|                                                                                               
|□REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF
THE SECURITIES EXCHANGE ACT OF 1934
|                                                                                               
|OR                                                                                             
|                                                                                               
|xANNUAL REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934          
|For the fiscal
    year ended December 31, 2006                                                
|                                                                                               
|OR                                                                                             
|                                                                                               
|□TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934      
|                                                                                               
|OR                                                                                             
|                                                                                               
|□SHELL 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)

1

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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      (  ) No2

---

TABLE OF CONTENTS

|PART I                                                            | 7 
|----------------------------------------------------------------- | --
|Introduction                                                      | 7 
|Forward-Looking Information                                       | 7 
|Item 1. Identity of Directors, Senior Management
    and Advisers | 8 
|Item 2. Offer Statistics and Expected Timetable                   | 8 
|Item 3. Key Information                                           | 8 
|A.Selected financial data.                                        | 8 
|Currency and Exchange Rates                                       | 9 
|B.Capitalization and indebtedness.                                | 9 
|C.Reasons for the offer and use of proceeds.                      | 9 
|D.Risk factors.                                                   | 9 
|Item 4-Information
    on the Company                             | 19
|A. History and Development of the Company                         | 19
|Acquisition and Development of Input Technology                   | 19
|Acquisition and Divestiture of Oztime                             | 21
|Acquisition and Divestiture of EnglishPractice
    Inc.           | 22
|Acquisition of Archer Education Group Inc.                        | 22
|Acquisition of Assets of Decuma AB                                | 23
|Intellectual Property Litigation                                  | 23
|Dispositions and Discontinued Operations                          | 24
|Telecom Technology Corporation Limited                            | 24
|The Magic Lantern Group of Companies                              | 24
|Acquisition of Zi Shares by the Lancer Funds                      | 25
|Principal Capital Expenditures and Divestiture                    | 27
|B. Business overview.                                             | 28
|Zi in General                                                     | 28
|Zi Technology Business Unit                                       | 28
|Description of eZiText and eZiType                                | 28
|Licensing of eZiText                                              | 30
|Description of Qix                                                | 30
|Description of Decuma Handwriting Recognition
    Solutions       | 30
|Investment in Archer Education Group Inc.                         | 31
|Geographic Segments                                               | 31
|C. Organizational Structure                                       | 32
|D. Property, plants and equipment.                                | 33
|Item 4A. Unresolved Staff Comments                                | 33
|Item 5. Operating and Financial Review and
    Prospects          | 33
|A.Operating results.                                              | 34
|Recent Developments:                                              | 35
|Critical Accounting Policies and Estimates                        | 35
|Software Development Costs                                        | 36
|Revenue Recognition                                               | 36
|Stock-Based Compensation Plan                                     | 36
|Contingencies                                                     | 37
|Accounting for Income Taxes                                       | 37

3

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|Recent accounting pronouncements                                                                                                           | 37
|------------------------------------------------------------------------------------------------------------------------------------------ | --
|Quarterly Overview                                                                                                                         | 38
|Operating Results                                                                                                                          | 40
|Net Loss                                                                                                                                   | 40
|Revenue                                                                                                                                    | 41
|Cost of Sales & Gross Margin                                                                                                               | 43
|Selling, General and Administrative Expenses                                                                                               | 43
|Legal                                                                                                                                      | 43
|Product Research and Development Expense                                                                                                   | 44
|Depreciation and Amortization                                                                                                              | 44
|Interest and Other Income                                                                                                                  | 45
|Income Tax Expense                                                                                                                         | 45
|Impact of Inflation and Changing Prices                                                                                                    | 45
|Impact of Governmental Policies and Other Factors
    on Operations and Investments                                                        | 45
|B.Liquidity and capital resources.                                                                                                         | 45
|Financial Condition and Liquidity                                                                                                          | 46
|Cash Requirements Outlook                                                                                                                  | 46
|Cash applied to Operating Activities                                                                                                       | 46
|Financing Activities                                                                                                                       | 47
|Investing Activities                                                                                                                       | 47
|Commitments and Contractual Obligations                                                                                                    | 47
|Transactions with Related Parties                                                                                                          | 48
|Off-Balance Sheet Arrangements                                                                                                             | 48
|Capital Expenditure Commitments                                                                                                            | 48
|C.Research and development, patents and licenses,
    etc.                                                                                 | 49
|D.Trend information.                                                                                                                       | 49
|Litigation/Indemnification                                                                                                                 | 49
|Subsequent Events                                                                                                                          | 50
|E.Off-balance sheet arrangements.                                                                                                          | 51
|F.Tabular disclosure of contractual obligations.                                                                                           | 51
|G.Safe harbor.                                                                                                                             | 51
|Item 6. Directors, Senior Management and
    Employees                                                                                     | 52
|A.Directors and senior management.                                                                                                         | 52
|B.Compensation.                                                                                                                            | 53
|(a) Compensation of Directors                                                                                                              | 53
|(b) Compensation of Executive Officers                                                                                                     | 54
|1. Summary Compensation                                                                                                                    | 54
|Summary compensation table                                                                                                                 | 54
|Stock Options                                                                                                                              | 55
|Aggregated Option/SAR and RSU exercises during
    the most recently completed financial year and financial year-end option/SAR
    values | 56
|Long-term Incentive Plans                                                                                                                  | 57
|Stock Appreciation Rights and Restricted Shares                                                                                            | 57
|Stock Option and SAR Repricing                                                                                                             | 57
|Pension and Retirement Plans and Payments made
    upon Termination of Employment                                                          | 57
|Employment Contracts                                                                                                                       | 57

4

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|(c) Plans and Share Options                                    | 59
|-------------------------------------------------------------- | --
|(d) Other Compensation                                         | 59
|C.Board practices.                                             | 59
|(a) Board of Directors                                         | 59
|Board Committees                                               | 59
|Audit Committee                                                | 59
|Compensation Committee                                         | 60
|Corporate Governance Committee                                 | 61
|D.Employees.                                                   | 61
|E.Share ownership.                                             | 62
|(a) Share and Option Holdings                                  | 62
|(b) Option Plans                                               | 63
|Purpose of Plans                                               | 63
|Eligibility                                                    | 64
|Administration of the Plans                                    | 64
|Amendment of the Plans                                         | 64
|Necessary Approvals                                            | 64
|Adjustment in Shares Subject to the Plan                       | 64
|Item 7. Major Shareholders and Related Party
    Transactions  | 66
|A.Major shareholders.                                          | 66
|B.Related party transactions.                                  | 67
|C.Interests of experts and counsel.                            | 69
|Item 8. Financial Information                                  | 69
|A.Consolidated Statements and Other Financial
    Information. | 69
|Legal Proceedings                                              | 69
|Dividend Policy                                                | 71
|B.Significant Changes.                                         | 71
|Item 9. The Offer and Listing.                                 | 71
|A.Offer and listing details  Stock Price History              | 71
|B.Plan of distribution.                                        | 72
|C.Markets.                                                     | 72
|D.Selling shareholders                                         | 72
|E.Dilution.                                                    | 72
|F.Expenses of the issue.                                       | 72
|Item 10. Additional Information.                               | 72
|A.Share capital.                                               | 72
|B.Memorandum and articles of association.                      | 73
|Directors                                                      | 73
|Common Shares                                                  | 74
|Preferred Shares                                               | 74
|Changing Rights of Shareholders                                | 74
|Shareholder Meetings                                           | 74
|Limitations on Right to Own Securities                         | 75
|Change of Control                                              | 77
|Disclosure of Ownership                                        | 77
|C.Material contracts.                                          | 77

5

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|D.Exchange controls.                                                                       | 77
|------------------------------------------------------------------------------------------ | --
|E.Taxation.                                                                                | 78
|Material Canadian Income Tax Consequences                                                  | 78
|Material United States Federal Income Tax
    Consequences                                 | 78
|F.Dividends and paying agents.                                                             | 84
|G.Statement by experts.                                                                    | 84
|H.Documents on display.                                                                    | 84
|I.Subsidiary Information.                                                                  | 84
|Item 11. Quantitative and Qualitative Disclosures
    About Market Risk.                   | 84
|(A) Quantitative information about market risk                                             | 84
|(B) Qualitative information about market risk                                              | 85
|Interest Rate Risk                                                                         | 85
|Foreign Exchange Rate Risk                                                                 | 85
|Item 12. Description of Securities Other than
    Equity Securities.                       | 85
|PART II                                                                                    | 85
|Item 13. Defaults, Dividend Arrearages and
    Delinquencies.                              | 85
|Item 14. Material Modifications to the Rights of
    Security Holders and Use of Proceeds. | 85
|Item 15. Controls and Procedures.                                                          | 85
|Item 16. [Reserved]                                                                        | 86
|Item 16A. Audit committee financial expert.                                                | 86
|Item 16B. Code of Ethics.                                                                  | 86
|Item 16C. Principal Accountant Fees and Services.                                          | 87
|Audit Fees                                                                                 | 87
|Audit Related Fees                                                                         | 87
|Tax Fees                                                                                   | 87
|All Other Fees                                                                             | 87
|Item 16D. Exemptions from the Listing Standards
    for Audit Committees.                  | 87
|Item 16E. Purchases of Equity Securities by the
    Issuer and Affiliated Purchasers.      | 87
|PART III                                                                                   | 87
|Item 17. Financial Statements.                                                             | 87
|Item 18. Financial Statements.                                                             | 87
|Item 19. Exhibits.                                                                         | 87
|EXHIBIT INDEX                                                                              | 89

6

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# PART
I



## **Introduction**



Zi
Corporation is a corporation incorporated under the laws of the province of
Alberta, Canada and is referred to in this document, together with its
subsidiaries, as "Zi", the "Company" or the "Corporation". Unless the context otherwise indicates, use of
"we", "us", "our" and like terms refers to the Company.



Trademarks or trade names of
Zi used in this document include, but are not limited to: Zi®,
eZiText®, eZiNet, eZiTap, eZiType, Qix, Decuma® and Zi Services.
Each trademark, trade name or service mark of any other company appearing in
this document belongs to its holder. Zi has obtained registered status on its
"eZiText" trademark in the United States, Canada, Australia, China, in other
parts of Asia and in parts of Europe. The wordmark, "Zi", is registered in
Canada, China, Japan, the United States, Singapore, Taiwan and Korea.



The Company's consolidated
financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America ("U.S. GAAP") and are
presented in United States dollars unless otherwise indicated. All references in
this Form 20-F to financial information concerning the Company refer to such
information in accordance with U.S. GAAP and all dollar amounts in this Form
20-F are in United States dollars unless otherwise indicated. Prior to the
preparation of the consolidated financial statements for the year ended December
31, 2003, the consolidated financial statements of Zi Corporation were prepared
in accordance with Canadian GAAP with an annual reconciliation of the Company's
financial position and results of operations as calculated using U.S. GAAP. In
order to provide information on a more comparable basis with its industry peers
and to better assist with the understanding of the financial statements to the
majority of users, who are in the United States, effective December 31, 2003,
the Company began reporting its financial position, results of operation and
cash flows under U.S. GAAP in its consolidated financial statements. Effective
March 31, 2004, the Company initiated reporting its consolidated financial
statements in U.S. dollars, with comparative periods restated to U.S. dollars.
The comparative amounts in this Form 20-F have been restated to U.S. dollars.



On March 23, 2007, the
exchange rate for the United States of America ("U.S.") dollar was $0.8621 =
CDN$1.00. Please see *Item 3 - Key Information - Selected Financial Data*
for more detailed U.S. dollar to Canadian dollar exchange rate information.



In this document,
cross-references relevant to the information being requested may be provided.
These cross-references are provided for ease of reference only and are not meant
to be exclusionary to other relevant information in this document that may
relate to the disclosure in question.



**Forward-Looking Information**



This Form 20-F annual report
contains "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Shareholders can identify these
forward-looking statements by the use of words such as "expect", "anticipate", "estimate",
"believe", "may", "potential", "intends", "plans" and other similar
expressions or statements that an action, event or result "may", "could" or "should" be taken, occur or be achieved, or the negative thereof or other
similar statements. These statements are only predictions and involve known and
unknown risks, uncertainties and other factors which may cause our actual
results, performance or achievements, or industry results, to be materially
different from any future results, performance, or achievements expressed or
implied by these forward-looking statements. These factors include, among
others, the following: our history of operating losses and uncertainty of future
profitability; risks associated with certain legal disputes between the Company
and the receiver for the Lancer group of funds (the "Receiver") and the
settlement thereof, including disruption of the Corporation's business and
diversion of management and financial resources, financing and market risks
associated with the ownership by the Receiver of approximately 40 percent of the
Corporation's outstanding shares; the possible impact of future financings;
uncertainty as to the degree of and continuing market acceptance of our products
and services; uncertainties relating to product development; risks associated
with the number, amount and timing of new product introductions; uncertainty
regarding patents, proprietary rights and software piracy; variability in
customer demand; our dependence on third party performance under marketing and
licensing arrangements; risks associated with the contingent nature of continued
performance under major sales contracts; rapid technological change, product
obsolescence and competition; uncertainty regarding the pricing and collection
of accounts; risks associated with dependence on sales in foreign countries; the
potential for adverse developments in pending litigation; risks associated with
the defense of its licensees in the University of Texas patent infringement
lawsuit; risks associated with the settlement of a U.S. patent infringement
lawsuit; fluctuations in foreign exchange rates; uncertainties associated with
changes in government policy and regulation, particularly in the People's
Republic of China ("PRC" or "China"); uncertainties associated with the Canadian
Revenue Agency's audit of the Company's cross border transactions; adverse
changes in general business conditions in any of the countries in which we do
business; changes in our size and structure; the effectiveness of our management
and our strategic relationships; risks related to possible defects in our
products; risks associated with our ability to attract and retain key personnel;
uncertainties regarding our need for additional capital; uncertainty regarding
the fluctuations of our quarterly results; risks related to our acquisitions of
companies and technologies; uncertainties relating to our status as a non-U.S.
corporation; risks associated with our investments and other risks and
uncertainties described under "*Item 3 - Key Information - Risk Factors*"
and elsewhere in this report.



7

---





Item 1. Identity of Directors, Senior
Management and Advisers



Not applicable



Item 2. Offer Statistics and Expected
Timetable



Not applicable



Item 3. Key Information



A.Selected financial
data.



The following table
summarizes certain of our selected financial information (stated in thousands of
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                                                         |          | **2005**
    **restated**(3) |  | **2004**
    **restated**(3) |   | **2003** |         | **2002** | 
|---------------------------------------------------------------- |  | ------------------------------------------------------------ | -------- | ---------------------------- |  | ---------------------------- | - | -------- | ------- | -------- | 
|                                                                 |  | **(in thousands of U.S. dollars except per
    share data)** |         
|Revenue from continuing
    operations                           |  |                                                              | 12,392   |                              |  | 11,385                       |   |          | 13,403  |          | 
|Operating loss from
    continuing operations (1)                |  |                                                              | (9,305   | )                            |  | (4,966                       | ) |          | (2,460  | )        | 
|Operating loss from
    continuing operations per share          |  |                                                              | (0.20    | )                            |  | (0.11                        | ) |          | (0.06   | )        | 
|Net loss from continuing
    operations (1)                      |  |                                                              | (10,995  | )                            |  | (5,317                       | ) |          | (2,724  | )        | 
|Net loss from continuing
    operations per share                |  |                                                              | (0.24    | )                            |  | (0.12                        | ) |          | (0.07   | )        | 
|Net loss (2)                                                     |  |                                                              | (10,995  | )                            |  | (5,317                       | ) |          | (2,724  | )        | 
|Basic and diluted net
    loss per share                         |  |                                                              | (0.24    | )                            |  | (0.12                        | ) |          | (0.07   | )        | 
|Total assets                                                     |  |                                                              | 14,547   |                              |  | 22,405                       |   |          | 21,699  |          | 
|Capital stock and
    additional paid-in capital                 |  |                                                              | 113,736  |                              |  | 111,480                      |   |          | 108,140 |          | 
|Accumulated deficit and
    accumulated other comprehensive loss |  |                                                              | (108,918 | )                            |  | (98,158                      | ) |          | (92,727 | )        | 
|Net assets                                                       |  |                                                              | 4,818    |                              |  | 13,322                       |   |          | 15,413  |          | 
|Outstanding shares, in
    thousands                             |  |                                                              | 46,689   |                              |  | 46,273                       |   |          | 45,225  |          | 
|                                                                 |  |                                                              |          |                              |  |                              |   |          |         |          | 

(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).



(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.



8

---





*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** |       
|------------------ |  | --------------------------------------- | ------
|                   |  | **September**
    **2006**              |       
|High for the month |  |                                         | 0.9047
|Low for the month  |  |                                         | 0.8871



Exchange rates are based
upon the noon buying rate in New York City for cable transfers in foreign
currencies, as certified for customs purposes by the Federal Reserve Bank of New
York. The noon rate of exchange on March 23, 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$1.1560.



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.



9

---





*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.



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



10

---





- 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:



§have sufficient resources to make
these investments;

§be successful in developing product
enhancements or new products on a timely basis, if at all; or

§be able to successfully market
these enhancements and new products once developed.



11

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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.



*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.



12

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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.



*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.



13

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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.*



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.*



14

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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.*



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.



15

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*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.



*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.



16

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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") throughits
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;

§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.



17

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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.



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.



18

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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.



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").



19

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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".



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.



20

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*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.



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$629,300.



21

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*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$629,300.

**

*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.



22

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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$629,300. The book value of the Archer shares sold had
previously been reduced to zero by Zi; therefore, the Company expects to record
a gain on the sale in the first quarter of 2007 of approximately US$629,300.

**

*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").
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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.



23

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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 Bluetooth 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



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.



24

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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.



*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.



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.



25

---





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 40 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.



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.



26

---





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**             |  | **To February 
    28, 2007**          
|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.



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.



27

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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.



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.



28

---





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.



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.



29

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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.



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.



30

---





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$629,300.



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.

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.



31

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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** |       | **Revenue Software and other** |  | **Total**
|-------- |  |  | --------- | ----------------------------------- | ----- | ------------------------------ |  | ---------
|2006     |  |  | Canada(1) |                                     | **$** | 5,832,869                      |  | **$**    
|         |  |  | China(2)  |                                     |       | 4,751,684                      |  |          
|         |  |  | USA(3)    |                                     |       | 935,956                        |  |          
|         |  |  | Sweden(4) |                                     |       | 315,708                        |  |          
|         |  |  | Total     |                                     | **$** | 11,836,217                     |  | **$**    
|**2005** |  |  | Canada(1) |                                     | **$** | 4,175,334                      |  | **$**    
|         |  |  | China(2)  |                                     |       | 5,019,599                      |  |          
|         |  |  | USA(3)    |                                     |       | 1,021,769                      |  |          
|         |  |  | Sweden(4) |                                     |       | 397,341                        |  |          
|         |  |  | Total     |                                     | **$** | 10,614,043                     |  | **$**    
|2004     |  |  | Canada(1) |                                     | $     | **5,884,396**                  |  | $        
|         |  |  | China(2)  |                                     |       | **5,207,579**                  |  |          
|         |  |  | USA(3)    |                                     |       | **1,806,863**                  |  |          
|         |  |  | Total     |                                     | $     | **12,898,838**                 |  | $        

**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) | Other product revenue recorded by the Company is mainly comprised of revenue
    for the e-Learning business segment.
|--- | ---------------------------------------------------------------------------------------------------------------------



|(3) | The
    actual geographic markets for products licensed under licensing agreements
    between OEMs and Zi Corporation of America, Inc. are in Asia and the United
    States.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(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                         
|                                                        |                             

32

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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 4A. Unresolved Staff Comments



Not applicable



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                                                                  |  | $    | 12,392  |      | $ | 11,385            |  
|                                                                         |  |      |         |      |   |                   |  
|Gross margin                                                             |  | $    | 11,963  |      | $ | 10,780            |  
|                                                                         |  |      |         |      |   |                   |  
|Net loss                                                                 |  | $    | (10,995 | )    | $ | (5,317            | )
|                                                                         |  |      |         |      |   |                   |  
|Total assets                                                             |  | $    | 14,547  |      | $ | 22,405            |  
|                                                                         |  |      |         |      |   |                   |  
|Net loss per share -
    basic and diluted                               |  | $    | (0.24   | )    | $ | (0.12             | )
|                                                                         |  |      |         |      |   |                   |  
|Outstanding shares,
    weighted average                                 |  |      | 46,503  |      |   | 46,153            |  
|                                                                         |  |      |         |      |   |                   |  
|Outstanding shares, end
    of year                                      |  |      | 46,689  |      |   | 46,273            |  



33

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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  eZiType 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.



34

---





**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 Qix, 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 platform, offered on
  millions of devices and supporting thousands of available mobile applications
  on the market.

- QixLinks and QixLinks
  Ads, 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 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 (PS3) 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.



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:



35

---





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 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 material impact to the amount of earned and
unearned income.



**Stock-Based Compensation Plan**



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.



36

---



# 

# 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.



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.



37

---





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.

#### 

#### Quarterly Overview



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



|                                        |   | 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              



38

---





|                                        |   | 2005              
|--------------------------------------- | - | ------------------
|(In millions, except per share amounts) |   | Fourth
    Quarter
|                                        |   |                   
|Total
    Revenues                      | $ | 2.9               
|Selling,
    general and administrative |   | 2.6               
|Legal                                   |   | 0.7               
|Product,
    research and development   |   | 1.2               
|Depreciation
    and amortization       |   | 0.3               
|Gain on
    Settlement of Litigation    |   | -                 
|Impairment
    of note receivable       |   | -                 
|Operating
    income (loss)             |   | (2.0)             
|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; provision for the
impairment of the note receivable with Archer of $0.1 million; and equity in the
net loss of Archer's operations of $0.4 million; all of which was not present in
the fourth quarter of the prior year.



Core business 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 core business 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.



SG&A expense for the 2006
fourth quarter was $3.2 million compared to $2.6 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.



39

---





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 $1.2 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                                                 |              | $    | 12.4     |      | $ | 11.4 |  | $       | 13.4 |        
|Operating loss                                          |              | $    | 9.3      |      | $ | 5.0  |  | $       | 2.5  |        
|Net Loss                                                |              | $    | 11.0     |      | $ | 5.3  |  | $       | 2.7  |        
|Loss per share                                          |              |      | 0.24     |      |   | 0.12 |  |         | 0.07 |        



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 consolidation and
  equity in the net loss from Archer's operations, as discussed below.



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.



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 $1.9 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.



40

---





In December 2005, we sold
our wholly-owned subsidiaries Beijing Oztime Education Network Co. Ltd. ("Oztime") and EnglishPractice
Inc. ("EPI") to Archer Education Group, Inc.
("Archer"), in exchange for shares in Archer, which resulted in us holding a
controlling interest in Archer.   As a result, the operating results of Archer
were consolidated with our operations from December 21, 2005 until the end of
February 2006 (represented within our e-Learning business segment), at which
time, from subsequent share subscriptions, Archer had diluted our interest into
a non-controlling position.  Since March 2006, Archer's operating results were
no longer consolidated with ours but were reported as "Equity in the net loss of
a significantly influenced company" within the Consolidated Statement of Loss
(hereby referred to as the "deconsolidation of the e-Learning").Since the
deconsolidation of the e-Learning we have refocused our efforts on our core
technology business described above.



Subsequent to December 31, 2006, we sold our
minority interest in Archer to an unrelated third party (see additional
discussion under the "Trends  Subsequent Events" section).   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. The following table shows the
impact of e-Learning on our revenue and expenses in the last three years. As the
result of the deconsolidation, we do not anticipate to recognize such revenue or
incur similar expenses in the future.



|(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  |  |         | 2.7 |         | 4% |        
|Equity in
    net loss of significantly influenced company |          |      | 0.9      |      |   |      |  |         |     |         |    |        



* not meaningful



##### 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 |        
|                                           |             |      |      |      |   |      |  |         |      |        



41

---





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,
in most situations, been able to offset these effects by signing agreements with
new licensees in Asia.



With the launch our new Qix
product and the advances we have made with the licensing our Decuma product, we
expect increased revenues in 2007.



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



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



42

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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. 
Cost of sales declined in 2006 as a result of the deconsolidation of our
e-Learning business segment (see discussion under the "Operating Result  Net
Loss").



##### 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   |             | $    | 11.9 |      | $ | 9.9  |  | $       | 9.3 |        
|                                    |             |      |      |      |   |      |  |         |     |        



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.



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 due to cost optimization initiatives that we have
implemented and 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 |        
|                                    |             |      |     |      |   |      |  |         |     |        



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 on going 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.



43

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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 matter 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 |             | $    | 5.8   |      | $ | 5.2   |  | $       | 4.1   |        
|Capitalized
    costs                      |             |      | (1.4) |      |   | (0.9) |  |         | (1.7) |        
|Product
    Research and Development       |             |      | 4.4   |      |   | 4.2   |  |         | 2.4   |        



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.



Gross PR&D expenditures
increased in 2005, compared to 2004, as a result of the acquisition of the
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  |  | $       | 0.4 |        
|Amortizaton
    of deferred software development costs |             |      | 1.1 |      |   | 0.6  |  |         | 0.5 |        
|Amortizaton
    of other intangibles                   |             |      | 0.2 |      |   | 0.2  |  |         | -   |        

* 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.



44

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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 $12.2 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 these 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.



##### 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.



##### 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.



45

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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                 |  |      | (7.4) |      |   | (1.1)
|Financing activities                 |  |      | 0.9   |      |   | 2.4  
|Investing activities                 |  |      | (3.5) |      |   | (1.8)



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 10, 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.



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.



46

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##### 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 $0.7million. $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 
was 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.

##### 

##### 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.



47

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As at December 31, 2005,
long-term liabilities include two loans payable to former shareholders of two
subsidiaries of Archer in the amount of $81,255 and $66,423, respectively. These
loans do not appear on the balance sheet as at December 31, 2006, as the
operating results of the e-Learning division have been deconsolidated (see
discussion under  "Operating Results  Net Income" ).



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 its foreign exchange requirements or its foreign assets.



##### Off-Balance Sheet Arrangements



We have no off-balance sheet
arrangements



48

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##### Capital Expenditure Commitments



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 a
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.  We continue to defend
the action on behalf of one of our customers.



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, 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 such orders and acknowledgement will be the
effective date of the Settlement Agreement (the "Effective Date").  The
Effective Date must occur within 120 days of the date of execution of the
Settlement Agreement. In addition, as of the Effective Date, the Receiver,
ourselves and our current and certain former directors have agreed to deliver
mutual releases.



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.



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.



49

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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.



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.



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.



50

---





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.



51

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Item 6. Directors, Senior Management and Employees



A.Directors and senior
management.



Each director is generally elected by a vote at
the annual meeting of shareholders in service for a term of one year. Each
executive officer will serve until his/her successor is elected or appointed by
the Board of Directors or his/her earlier removal or resignation from office.
There are no family relationships between any of our executive officers and our
directors. The following table lists the directors and senior management of the
Company together with their respective positions, since 2006:



|**Name**                                                                               |  | **Position or office within Corporation**         
|-------------------------------------------------------------------------------------- |  | --------------------------------------------------
|Milos
    Djokovic
    Parker,
    Colorado, U.S.A.                                    |  | Director
    President and Chief Executive Officer
|H. Donald
    Hyde(1) (2) (4) (6)
    Calgary,
    Alberta, Canada                     |  | Director                                          
|Michael E.
    Lobsinger
    Calgary,
    Alberta, Canada                              |  | Director                                          
|Donald P. Moore(1)
    (3)(6)
    Miami, Florida, U.S.A.                               |  | Director                                          
|Richard D. Tingle(2)(3) (5)
    Calgary, Alberta, Canada                               |  | Chairman of the Board of Directors
    Director   
|Robert P.
    Stefanski(1) (3)
    Palo Alto,
    California, U.S.A.                   |  | Director                                          
|Blair Mullin
    Salem, Oregon, U.S.A.                                                 |  | Chief Financial Officer                           
|Derrick R. Armstrong
    Calgary, Alberta, Canada                                      |  | Corporate Secretary                               
|Howard R Balloch (5) (7)
    Beijing, China                                            |  | -                                                 
|Angus Michael Roderick
    Mackenzie(4) (6) (7)
    Englefield Green,
    Surrey, U.K. |  | -                                                 
|Thompson MacDonald(4)
    (5) (7)
    Calgary, Alberta, Canada                         |  | -                                                 

**Notes:**

(1)  Currently member of the Audit Committee.

(2)  Currently member of the
Corporate Governance Committee.

(3)  Currently member of the
Compensation Committee.

(4) Member of the Audit
Committee during 2006.

(5) Member of the Corporate
Governance Committee during 2006.

(6) Member of the
Compensation Committee during 2006.

(7) Ceased being director on
December 22, 2006.



MILOS DJOKOVIC became the
Company's President and Chief Executive Officer, as well as a member of the
Board of Directors, in May 2006. From October 2004 and until May 2006, Mr. Djokovic served as the Company's Chief Operating Officer and Chief Technical
Officer. Mr. Djokovic was the founder in 1992 of Cygnus Corporation, an Ontario
based developer of customer relationship management software, which he sold in
1998 to TeleTech Holdings Inc., and continued to serve as its chief technical
officer until March 2003. Mr. Djokovic also served as CEO of TeleTech's Enhansiv
division from 2000-2002.  From August 2003 until October 2004, Mr. Djokovic was
employed with Accenture, an international management consulting firm, where he
was responsible for that firm's customer relationship technology strategy.



H. DONALD HYDE was elected
as a director at the Company's annual general meeting held in June 2003 and is
currently the chair of the Audit Committee and serves on the Corporate
Governance Committee. Mr. Hyde is a chartered accountant and has had his own
practice since 1991. Prior to setting up his own practice, Mr. Hyde was the vice
president of finance and administration for an international oil and gas
drilling and service company.



52

---





MICHAEL E. LOBSINGER has
been a director of the Company since 1987.  Mr. Lobsinger was the Chairman of
the Board from 1987 to May, 2006, the Chief Executive Officer of the Company
from 1993 to November 2003 and President of the Company from 1993 to 2000.  As
well, Mr. Lobsinger assumed the position of President and Chief Executive
Officer from May 2005 to May 2006 as a result of the resignation of Michael D.
Donnell, who had served as the Company's Chief Executive Officer from November
2003 to May 2005. According to the terms of the settlement agreement between the
Company and the Receiver, signed in February 2007, Michael Lobsinger has
conditionally agreed to resign as a director of the Company on the Settlement
Agreement Effective Date, but will remain on as a consultant of the Company
until December 31, 2007 - see Item 4  Information on the Company  History
and Development of the Company.



DONALD P. MOORE was elected
to the Board in August 2004, pursuant to an agreement between the Company and
the receiver for the Lancer group of funds dated July 15, 2004. The Agreement
was entered into in consideration for the Lancer Group of Funds entering into an
undertaking that restricted their ability to trade shares of the Company for a
period of time (that has since expired), given to an agent under an offering of
securities by the Company that closed in July 2004. Mr. Moore is currently a
member of the Audit Committee and the Compensation Committee. Mr. Moore is a
lawyer in the Miami office of Holland & Knight LLP. Mr. Moore is also a
principal and director of Fundamental Management Corporation, an investment fund
advisor.



RICHARD D. TINGLE, Q.C. was
elected to the Board in December 2004 and has served as the Chairman of the
Board since May 2006. Mr. Tingle is currently the chair of the Corporate
Governance Committee and a member of the Compensation Committee. Since 1992 Mr.
Tingle has been a lawyer with Tingle Merrett LLP (formerly Tingle & Associates).
Mr. Tingle is a director of Intermap Technologies Inc., Venpath Investments Ltd.
and Emerald Bay Energy Inc., each a publicly traded company.



ROBERT PAUL STEFANSKI was elected to the Board
on December 22, 2006. Mr. Stefanski is currently the chair of the Compensation
Committee and a member of the Audit Committee. Mr. Stefanski is an executive
vice president with TIBCO Software Inc., a software company headquartered in
Palo Alto, California.Prior to joining
TIBCO, Mr. Stefanski practiced law in New York with Weil, Gotshal & Manges, a
major international law firm. He also served as Director of Intellectual
Property for financial news and information provider Reuters.



PHILIP BLAIR MULLIN was
appointed Chief Financial Officer of the Company on August 25, 2006. Mr. Mullin
has been a Partner in the Portland practice of Tatum, LLC since 2003, and has
served as Interim Chief Financial Officer and provided financial leadership for
two consumer products companies, a $100 million industrial construction firm and
several manufacturers. Prior to joining Tatum, Mr. Mullin was President and
Chief Operating Officer for International DisplayWorks, Inc., a manufacturer of
LCD displays and modules; and Chairman, President and Chief Financial Officer of
Morrow Snowboards. Mullin has held other leadership positions at Westbeach
Canada, ULC, British Columbia Mercantile Corp., and Padovano Foods, Ltd.



DERRICK R. ARMSTRONG has served as the Company's
corporate secretary since 1992. He also served as a director of the Company from
1992 to December 2006. Mr. Armstrong is a lawyer and partner with Borden Ladner
Gervais LLP, Barristers & Solicitors, practicing primarily in securities and
corporate commercial law. Mr. Armstrong is also a director of Cygam Energy Inc.,
and Centurion Energy International Inc., both publicly traded resource
companies.



According to the terms of
the settlement agreement between the Company and the Receiver, signed in
February 2007, both the Receiver and Mr. Lobsinger each have the right to
designate two persons as director nominees to be elected or appointed as
directors of the Corporation, 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. Currently, Mr. Moore
and Mr. Stefanski are the Receiver's nominees, and Mr. Tingle and Mr. Hyde are
Mr. Lobsinger's nominees. Notwithstanding these designations for the purposes of
the settlement agreement, each of these directors continues to act as
independent directors. See Item 4  Information on the Company  History and
Development of the Company



53

---





B.Compensation.



(a)  Compensation of Directors



Executive officers of the
Corporation, who also act as directors of Zi Corporation, do not receive any
additional compensation for services rendered in such capacity, other than as
paid by the Corporation to such executive officers in their capacity as
executive officers. (See "Compensation of Executive Officers")



On September 26, 2001, the
Board approved director compensation, effective January 1, 2002, of $10,000 per
annum, payable in bi-annual instalments on the 1st day of January and
July of each year. In light of increased responsibilities required to be
undertaken by directors of public companies, on May 25, 2005, the Board adopted
the following recommendations made by the Compensation Committee to take effect
retroactive to January 1, 2005: An annual director fee of $10,000 per director;
a fee of $2,500 per board meeting attended in person and $1,250 per Board
meeting attended by phone per director; no fees for attendance at committee
meetings; maximum fee per annum is $20,000 per director, provided however that
if a fifth "in person" meeting of directors in a fiscal year is held, then an
additional $2,500 would be paid to directors that attend such fifth meeting over
and above this maximum amount; payments are made quarterly; in addition, each
director would receive 50,000 options on the date of the Annual General Meeting.
In 2006, the directors' compensation plan called for each director to receive
50,000 stock options and 12,495 RSUs each year, as well as CDN $500 for each
committee meeting attended.



The Corporation reimburses
all travel and other expenses of directors while conducting business on behalf
of the Corporation.



During the fiscal period
ended December 31, 2006, stock options and RSUs to purchase 437,468 common
shares were granted to directors of the Corporation, pursuant to the 2006
directors' compensation plan, not including options granted to each of Milos
Djokovic and Michael E. Lobsinger in their respective capacity as Executive
Officers of the Corporation. See "Compensation of Executive Officers" for
details on stock options granted to Messrs. Djokovic and Lobsinger.



(b)  Compensation of Executive Officers



1.
Summary Compensation



The following table sets
forth all annual and long-term compensation for services in all capacities to
the Corporation for the period ended December 31, 2006, in respect of
individual(s) who were acting in a capacity of chief executive officer, chief
financial officer, and the three other most highly compensated executive
officers who earned in excess of CDN $150,000 in total salary and bonus during
the fiscal year ended December 31, 2006 (the "**Named Executive Officers**").



*Summary compensation table*



|                                                                                                             |                            | **Annual Compensation(6)**          | **Long-Term Compensation**       |                                                
|------------------------------------------------------------------------------------------------------------ | -------------------------- | ----------------------------------- | -------------------------------- | -----------------------------------------------
|                                                                                                             |                            |                                     |                                  |                                                
|**Name and
      principal position**                                                                        | **Year**                   | **Salary**
      **($U.S.)**        | **Bonus**
      **($U.S.)**      | **Other annual compensation**
      **($U.S.)**
|Michael E. Lobsinger(1)
      (past Chairman and
      past Interim Chief Executive Officer)                 | 2006
      2005
      2004 | 274,054
      293,648
      159,478 | 88,156
      Nil
      180,427   | Note(8)
      Note(8)
      Note(8)            
|MilosDjokovic(2)
      President and Chief
      Executive Officer(previously Chief
      Operating Officer) | 2006
      2005
      2004 | 275,417
      230,000
      42,756  | 60,000
      Nil
      Nil       | Note(8)
      Note(8)
      Note(8)            
|Dale Kearns(3)
      Past Chief Financial
      Officer                                                      | 2006
      2005
      2004 | 100,415
      103,745
      87,388  | 35,262
      30,337
      57,644 | 34,248(7)
      49,333(7)
      46,067(7)      
|Roland Williams(4)
      Senior Vice President
      Technical Innovations                                   | 2006
      2005
      2004 | 180,000
      158,750
      162,500 | Nil
      10,000
      7,500     | Nil
      Nil
      Nil                        
|Axel Bernstorff(5)
      Vice President, Global
      Sales                                                  | 2006
      2005
      2004 | 142,601
      42,396
      Nil      | Nil
      Nil
      Nil          | 51.176
      Nil
      Nil                     
|Blair Mullin (6)
      Chief Fincial Officer                                                                 | 2006                       | 109,706                             | Nil                              | Nil                                            



54

---





**Notes:**

(1) Mr. Lobsinger was the
Chairman and Chief Executive Officer of the Corporation from 1993 to 2003 and
acted as Interim Chief Executive Officer from May 26, 2005 until May 26, 2006 at
which time he resigned as Chairman and Interim Chief Executive Officer.

(2) Mr. Djokovic was
appointed as President and Chief Executive Officer on May 26, 2006. Mr. Djokovic
was appointed Chief Operating Officer and Chief Technology Officer on October
25, 2004.

(3) Mr. Kearns was appointed
Chief Financial Officer on April 2, 2001 and resigned on August 25, 2006.

(4) Dr. Williams has been
employed by the Corporation in various capacities and at various times, since
July 1995.

(5) Mr. Bernstorff was
appointed VP Global Sales on September 15, 2006, from his previous position as
Director Sales, Europe on joining the Company on August 30, 2005.

(6) Mr. Mullin was appointed
Chief Financial Officer on August 25, 2006, pursuant to an agreement with an
executive services and consulting firm.

(7) Mr. Kearns provided
services during 2006, 2005 and 2004 to certain subsidiaries of the Corporation
for which his holding company, MKS Ventures Inc, was compensated directly by
those subsidiaries in the amounts shown.

(8) For 2006 compensation,
all Canadian dollar denominated compensation was converted to U.S. dollars at
0.8816, being the average conversion rate for 2006. Other annual compensation is
less than CDN$50,000 and less than 10 percent of the salary and bonus of the
respective Named Executive Officer.



*Stock Options*



The following table sets
forth information in respect of all stock options granted to the Named Executive
Officers of the Corporation during the fiscal year ended December 31, 2006.



|**Name**                     | **Securities under Options/SARs 
    granted (#)** | **Percent of total Options/SARs granted 
    to
    employees in 
    financial year(1)** | **** | **Exercise or base 
    price ($/Security)** | **Market value of 
    Securities underlying
    Options/SARs/ RSUs 
    on the date of grant**
    **($/Security)** | **Expiration 
    date**
|---------------------------- | -------------------------------------------------- | ----------------------------------------------------------------------------------------- | ---- | -------------------------------------------- | -------------------------------------------------------------------------------------------------------------------- | ------------------------
|Michael E. Lobsinger
    (2) | 100,000                                            | 6.3                                                                                       | %    | Note(2)                                      | Note(2)                                                                                                              | Note(2)                 
|Milos Djokovic (3)           | 200,000                                            | 12.7                                                                                      |      | Note(3)                                      | Note(3)                                                                                                              | Note(3)                 
|Axel Bernstorff(4)           | 110,000                                            | 7.0                                                                                       |      | Note(4)                                      | Note(4)                                                                                                              | Note(4)                 
|Dale Kearns(5)               | 200,000                                            | 12.7                                                                                      |      | Note(5)                                      | Note(5)                                                                                                              | Note(5)                 
|Roland Williams(6)           | 100,000                                            | 6.3                                                                                       |      | Note(6)                                      | Note(6)                                                                                                              | Note(6)                 
|Blair Mullin(7)              | Nil                                                | 0.0                                                                                       |      | Note(7)                                      | Note(7)                                                                                                              | Note(7)                 

**Notes:**

(1) During the year, stock
options and RSUs exercisable into a total of 1,580,468 common shares were
granted to directors, officers, and employees of the Company.

(2) During the year, the
Corporation issued to Mr. Lobsinger options to acquire 100,000 common shares at
CDN$2.01 expiring April 3, 2011.  The market value of the common shares at the
date of the grant was the same as the exercise price for the options granted to
Mr. Lobsinger in 2006.

55

---





(3) During the year, the
Corporation issued to Mr. Djokovic options to acquire 200,000 common shares at
CDN$2.01 expiring April 3, 2011. The market value of the common shares at the
date of the grant was the same as the exercise price for the options granted to
Mr. Djokovic in 2006.

(4) During the year, the
Corporation issued the following stock options to Mr. Bernstorff: options to
acquire 10,000 common shares at CDN$2.01 expiring April 3, 2011; and, options to
acquire 100,000 common shares at CDN$0.96 expiring September 15, 2011. The
market value of the common shares at the date of the grant was the same as the
exercise price for the options granted to Mr. Bernstorff in 2006.

(5) During the year, the
Corporation issued to Mr. Kearns options to acquire 200,000 common shares at
CDN$2.01 expiring April 3, 2011. The market value of the common shares at the
date of the grant was the same as the exercise price for the options granted to
Mr. Kearns in 2006.  These options have since been forfeited on November 24,
2006 following Mr. Kearns resignation from Zi in August 2006.

(6) During the year, the
Corporation issued the following stock options to Dr. Williams: options to
acquire 50,000 common shares at CDN$2.01 expiring April 3, 2011; and, options to
acquire 50,000 common shares at CDN$0.99 expiring September 6, 2011. The market
value of the common shares at the date of the grant was the same as the exercise
price for the options granted to Dr. Williams in 2006.

(7) During 2006, the Corporation issued no stock
options to Mr. Mullin.



The following table sets
forth information in respect of all stock options and RSUs which were either
exercised or not exercised by the Named Executive Officers during the
Corporation's fiscal year ended December 31, 2006.



**Aggregated Option/SAR and RSU exercises
during the most recently completed financial year and financial year-end
option/SAR values**



|**Name**             | **Securities****acquired on****exercise**
    **(#)** | **Aggregate value****realized(1)**
    **($U.S.)** | **Unexercised****Options/SARS/RSUs as****at December 31, 2006****exercisable/**
    **unexercisable(#)** | **Value
    of unexercised****in-the-Money****Options/SARs/RSUs at****December 31, 2006(2)****exercisable/**
    **unexercisable
    ($U.S.)**
|-------------------- | ----------------------------------------------------- | -------------------------------------------------- | -------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------
|Michael E. Lobsinger | 378,57l                                               | 420,214                                            | Exercisable
    900,000
    Unexercisable
    Nil                                                        | Exercisable
    42,046
    Unexercisable
    Nil                                                                                              
|Milos Djokovic       | Nil                                                   | Nil                                                | Exercisable
    520,000
    Unexercisable
    Nil                                                        | Exercisable
    84,091
    Unexercisable
    Nil                                                                                              
|Axel Bernstorff      | Nil                                                   | Nil                                                | Exercisable
    16,666
    Unexercisable
    103,334                                                     | Exercisable
    4,205
    Unexercisable
    132,143                                                                                           
|Roland Williams      | Nil                                                   | Nil                                                | Exercisable
    80,250
    Unexercisable
    50,000                                                      | Exercisable
    21,023
    Unexercisable 64,785                                                                                               
|Dale Kearns          | Nil                                                   | Nil                                                | Exercisable
    Nil
    Unexercisable
    Nil                                                            | Exercisable
    Nil
    Unexercisable
    Nil                                                                                                 
|Blair Mullin         | Nil                                                   | Nil                                                | Exercisable
    Nil
    Unexercisable
    Nil                                                            | Exercisable
    Nil
    Unexercisable
    Nil                                                                                                 



56

---





**Notes:**



(1) The aggregate of the
difference between the market value of the underlying securities at the time of
exercise and the exercise price.

(2)
"In-the-money" options
refer to those options in respect of which the market value of the underlying
security as at the financial year-end, exceeds the exercise or base price of the
option, being the aggregate of the difference between the market value of the
securities as at December 31, 2006 and the exercise price.



*Long-term Incentive Plans*



The Corporation currently
has no long-term incentive plans, other than stock options granted from time to
time by the Board under the provisions of the Corporation's Incentive Stock
Option Plans described herein.



*Stock Appreciation Rights and Restricted Shares*



No stock appreciation rights
were granted by the Company to the Named Executive Officers of the Company
during the last fiscal year ended December 31, 2006 or since incorporation. In
2006, 87,468 RSUs were granted and issued, in respect of compensation, without
performance criteria attached and at no cost to the grantee.****



*Stock Option and
SAR Repricing*



No repricing took place during the fiscal year
ended December 31, 2006 with respect to stock options held by the Named
Executive Officers.



*Pension and Retirement Plans and Payments
made upon Termination of Employment*



The Corporation does not
have any pension or retirement plan which is applicable to the Named Executive
Officers other than as described below. The Corporation has not provided
compensation, monetary or otherwise, during the preceding fiscal year, to any
person who now acts or has previously acted as a Named Executive Officer of the
Corporation, in connection with or related to the retirement, termination or
resignation of such person other than as described in the succeeding paragraph
and the Corporation has provided no compensation to such persons as a result of
a change of control of the Corporation, its subsidiaries or affiliates. The
Corporation is not party to any compensation plan or arrangement with any person
who now acts as a Named Executive Officer resulting from the resignation,
retirement or the termination of employment of such person other than as
described herein



*Employment Contracts*



The Corporation entered into
an employment agreement with Milos Djokovic on October 25, 2004 (as amended)
pursuant to which Mr. Djokovic was appointed Chief Technology Officer and Chief
Operating Officer of the Corporation. The terms of the agreement provided for
Mr. Djokovic to be paid a base salary of U.S.$230,000 per annum. The Corporation
may terminate Mr. Djokovic's employment upon payment of twenty-four months' base
salary plus an allowance for a bonus and forgone benefits. The Corporation
agreed, subject to regulatory approvals, to grant Mr. Djokovic stock options to
purchase 230,000 common shares in the capital of the Corporation. Effective May
26, 2006,  Mr.Djokovic was promoted to President and CEO and his base salary
increased to U.S. $300,000 per annum Pursuant to Mr. Djokovic's employment
contract, in the event of a change of control of the Corporation, all of his
options vest immediately. Mr. Djokovic was required to execute a Confidentiality
and Non-Competition agreement.



The Corporation entered
into an Interim Executive Services Agreement with an executive services and
consulting firm on August 23, 2006 pursuant to which Blair Mullin was appointed
Chief Financial Officer of the Corporation. The terms of the agreement provide
for Mr. Mullin to be paid a base salary of U.S.$288,000 per annum. The
Corporation may terminate Mr. Mullin's employment upon payment of thirty days
written notice.



57

---





The Corporation entered into
an employment agreement with Michael E. Lobsinger dated December 31, 1999 for a
term that commenced on January 1, 2000 and ended on December 31, 2002. The
agreement provided for an automatic renewal for a further three years on the
same terms and conditions except for remuneration which was to be renegotiated.
The terms of the agreement provided that Mr. Lobsinger be paid an amount equal
to U.S.$300,000 per annum plus transportation and travel allowances. Effective
May 1, 2003, Mr. Lobsinger agreed to defer two-thirds of his remuneration until
a later date, and the Corporation ceased paying Mr. Lobsinger the full amount of
his salary. Effective November 20, 2003 Mr. Lobsinger and the Corporation agreed
that the positions of Chairman of the Board and Chief Executive Officer would be
separated, such that Mr. Lobsinger would no longer be Chief Executive Officer of
the Corporation but would remain as Chairman of the Board. The Corporation and
Mr. Lobsinger entered into an amending agreement in March 2004 that amended the
terms of his employment agreement effective November 20, 2003 (the "Amending
Agreement") (Mr. Donnell became Chief Executive Officer of the Corporation on
that date). Mr. Lobsinger agreed to amend the terms of his employment to reduce
his salary to an annual compensation of CDN$225,000 per year effective November
20, 2003. In addition, as of November 20, 2003, Mr. Lobsinger had deferred
CDN$240,340 in salary payable to him under his employment agreement, which he
agreed to further defer until December 31, 2006, unless the directors determined
to pay it earlier. This amount was paid to Mr. Lobsinger on September 17, 2004.
Mr. Lobsinger agreed to forego any additional options that he would have been
entitled to under his 1999 employment agreement, and instead the Corporation
agreed to issue to him 400,000 options and 250,000 RSUs. Under the Amending
Agreement, following a change of control, Mr. Lobsinger has the right,
exercisable within 60 days of a change of control, to consider his employment to
have been terminated. In the event the Corporation terminated Mr. Lobsinger's
employment (or if Mr. Lobsinger elected to treat his employment as terminated on
a change of control) the Corporation would be required to pay him an amount
equal to three times his current annual salary and at Mr. Lobsinger's
discretion, an amount equal to the difference between the fair market value of
all options, whether vested or not, and the exercise price. In addition, any
salary amounts deferred by Mr. Lobsinger as of the date of his termination
become payable upon such termination. On May 26, 2005, Mr. Lobsinger was
appointed President and Chief Executive Officer of the Company. Effective May
26, 2005 and as approved by the Board of Directors on July 21, 2005, Mr.
Lobsinger's annual cash compensation was temporarily adjusted to CDN$396,000 to
reflect his increased responsibilities and until such time that the Company
filled the Chief Executive Officer position. Mr. Lobsinger was required to
execute a Confidentiality and Non-Competition agreement. Mr. Lobsinger resigned
from the position of Chairman, President and Chief Executive Officer on May 26,
2006.



The Corporation entered
into an employment agreement with Dale Kearns on April 2, 2001 pursuant to which
Mr. Kearns was appointed Chief Financial Officer of the Corporation. The terms
of the agreement provided for Mr. Kearns to be paid a base salary of CDN$180,000
per annum. Effective May 26, 2005, and as approved on July 21, 2005 by the Board
of Directors, Mr. Kearns' annual compensation was increased to CDN$200,000.
Pursuant to a 2004 amendment to the employment agreement, the Corporation may
terminate Mr. Kearns' employment upon payment of twelve months' base salary plus
an allowance to replace group insurance benefits post-termination of employment.
Pursuant to Mr. Kearns' employment contract, in the event of a change of control
of the Corporation, all of his options vest immediately. Mr. Kearns was required
to execute a Confidentiality and Non-Competition agreement. Mr.Kearns resigned
from the Corporation effective August 25, 2006.



The Corporation entered into
an employment agreement with Roland Williams on February 5, 2001 pursuant to
which Dr. Williams was appointed Senior Vice President  Technical Innovations.
The terms of the agreement provided for Dr. Williams to be paid a base salary of
U.S. $150,000 per annum. Effective June 1, 2005 Dr. Williams' base salary
increased to U.S. $165,000 per annum. Effective January 1, 2006 Dr. Williams'
base salary increased to U.S. $180,000 per annum. The Corporation may terminate
Dr. Williams' employment upon payment of an amount equal to the Base Salary. Dr.
Williams was required to execute a Confidentiality and Non-Competition
agreement.



The Corporation entered into
an employment agreement with Axel Bernstorff on July 19, 2005 pursuant to which
Mr.Bernstorff was appointed Director of Sales  Europe. The terms of the
agreement provided for Mr.Bernstorff to be paid a base salary of 70,000 British
Pounds per annum. Effective September 15, 2006 Mr.Bernstorff was promoted to
Vice President  Global Sales and as such his base salary increased to 95,000
British Pounds per annum. The Corporation may terminate Mr.Bernstorff's
employment upon payment of three months' annual remuneration. Pursuant to Mr.Bernstorff's employment contract, in the event of a change of control of the
Corporation, all of his options vest immediately. Mr.Bernstorff was required to
execute a Confidentiality and Non-Competition agreement.

58

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(c)  Plans and Share Options



The Company currently has in effect 1993, 1995,
1996, 1998 and 1999 Incentive Share Option Plans for its directors, officers,
employees and consultants pursuant to which 11,879,382common shares were
reserved for issuance and an additional 1,035,618 common shares which were
reserved for issuance pursuant to shareholder approval which was obtained at the
June 5, 2002 shareholder meeting.



The following summarizes
aggregate stock option plan activity during the fiscal years ending December 31,
2004, 2005 and 2006:



|                                           | 2006       |   | **2005**   |   | **2004**      |     
|------------------------------------------ | ---------- | - | ---------- | - | ------------- | ----
|Options outstanding,
    beginning of year | 4,106,487  |   | 4,911,972  |   | 5,474,904     |     
|Granted                                    | 1,580,468  |   | 940,375    |   | 2,105,500     |     
|Cancelled                                  | (1,270,917 | ) | (1,454,893 | ) | (1,524,666    | )   
|Exercised                                  | (416,056   | ) | (290,967   | ) | (1,143,766    | )   
|Options outstanding, end
    of year       | 3,999,982  |   | 4,106,487  |   | **4,911,972** | ****



(d)  Other Compensation



During the Corporation's
fiscal year ended December 31, 2006, the Corporation accrued and/or paid legal
fees to a law firm of which Derrick Armstrong is a partner amounting, in the
aggregate, to $158,078.



During the Corporation's
fiscal year ended December 31, 2006, the Corporation accrued and/or paid
consulting fees to a consulting firm of which Dale Kearns was an owner
amounting, in aggregate, to $34,248.



During the Corporation's
fiscal year ended December 31, 2006, the Corporation accrued and/or paid
consulting fees to a consulting firm of which Blair Mullin was a partner
amounting, in aggregate, to $66,006.



The Corporation has set
forth herein all required disclosure of additional compensation to the executive
officers or directors (including personal benefits and securities or properties
paid or distributed, which compensation was not offered on the same terms to all
full-time employees) during the last completed fiscal year.



C.Board practices.



(a)  Board of Directors



The Board currently consists
of six members. Each director elected holds office until the next annual meeting
of shareholders or until his successor is duly elected, unless his office is
earlier vacated in accordance with the Bylaws of the Company. See also Item
6A. Directors and Senior Management.



Board Committees



Our Board of Directors has
three standing committees: an Audit Committee, a Compensation Committee and a
Corporate Governance Committee.



*Audit Committee*



The Audit Committee consists
of three members. Mr. Donald Hyde, who is a chartered accountant in private
practice, joined the Board in June, 2003 and was appointed Chairman of the Audit
Committee. Mr. Hyde was specifically recruited to the Corporation's Board of
Directors for his financial and accounting skills. During 2006, the other
members of the Audit Committee were Thompson MacDonald and Michael Mackenzie who
are both financially literate and possess an understanding of the accounting
principles, internal controls and procedures used by the Company. Messrs.
MacDonald and Mackenzie served as directors or senior officers of companies who
prepare financial statements similar to those of the Company and have experience
supervising one or more persons engaged in the preparation of financial
statements. Messrs. MacDonald and Mackenzie ceased serving on the Corporation's
Board of Directors on December 22, 2006. Subsequently, Robert Stefanski and
Donald Moore, who are both financially literate and possess an understanding of
the accounting principles, internal controls and procedures used by the Company,
were appointed as members of the Audit Committee. All members of the Audit
Committee are outside and unrelated directors and independent from any interest
in the Corporation. The Committee met five times in 2006.



59

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The Corporation adopted an
Audit Committee Charter in June 2000 which was amended in 2005 to conform with
applicable requirements. A copy of the Audit Committee Charter is filed as an
exhibit to this Report. The stated purpose of the Audit Committee is to serve as
an independent and objective party to monitor the integrity of the Corporation's
financial reporting process and system of internal controls, to review, appraise
and monitor the independence and performance of the Corporation's independent
auditors and to provide an avenue for open communication among the independent
auditors, management and the Board of Directors. All members of the Audit
Committee are financially literate and possess an understanding of the
accounting principles, internal controls and procedures used by the Company. In
addition, the Audit Committee approves the fees and other significant
compensation to be paid to the independent auditors. The Audit Committee has
direct access to the independent auditors at all times and has the ability to
retain, at the Corporation's expense, special legal, accounting or other
consultants or experts it deems necessary in the performance of its duties.



*Compensation Committee*



During 2006, the
Compensation Committee consisted of Michael Mackenzie, as Chairman, Donald Moore
and Donald Hyde. Mr. Mackenzie ceased serving on the Corporation's Board of
Directors on December 22, 2006. The Compensation Committee currently consists of
Robert Stefanski, as Chairman, Donald Moore and Richard Tingle. Under its
charter, the Compensation Committee is responsible for reviewing management
prepared policies and recommending to the Board of Directors the compensation
policies and guidelines for senior officers and management personnel, corporate
benefits, incentive plans, evaluation of the performance and compensation of the
Chief Executive Officer and other senior management, compensation levels for
members of the Board of Directors and committee members, a succession plan for
the Chief Executive Officer and key employees of the Corporation and any
material changes in human resources policy, procedure, remuneration and
benefits.



The Compensation Committee
advises the board on the administration of the Company's Stock Option Plans, and
reviews and approves the recommendations of senior management relating to the
annual salaries, bonuses and stock option grants of the executive officers of
the Company. The Compensation Committee consists of outside directors who report
to the Board, which in turn gives final approval to compensation matters.



Under the direction of the
Compensation Committee, the Company is committed to the fundamental principles
of pay for performance, improved shareholder returns and external
competitiveness in the design, development and administration of its
compensation programs. The Compensation Committee recognizes the need to attract
and retain a stable and focused leadership with the capability to manage the
operations, finances and assets of the Company. As appropriate, the Compensation
Committee recognizes and rewards exceptional individual contributions with
highly competitive compensation. The major elements of the Company's executive
compensation program are salary, annual cash incentives and long-term
incentives, through the granting of stock options and RSUs.



In connection with
determining base salaries, the Company maintains an administrative framework of
job levels into which positions are assigned based on internal comparability and
external market data. The Compensation Committee's goal is to provide base
salaries, for its top performing employees, that are competitive with the
Company's peers and which also recognizes the differentials from such peers. The
Committee references outside data consisting of management compensation surveys
and reports and compares the base salaries of the Company's executive officers
with compensation data for comparable organizations available from such surveys
and reports.



Annual cash incentive awards
are given pursuant to a cash incentive plan, approved by the Board.
Participation is determined according to job level and is intended to reward
those individuals who have had, and will have, a significant impact on business
results. The total amount of cash available for annual incentive awards is
proposed by the Compensation Committee, and approved by the Board, by evaluating
some or all of financial and non-financial criteria, including revenue, net
income/operating profit, cash flow, net asset value growth and achievement of
specific strategic goals. Individual target award levels increase in relation to
job responsibilities so that the ratio of at-risk versus fixed compensation is
greater for higher levels of management. Individual awards are intended to
reflect a combination of personal, business unit and total company performance.
In 2006, the Board approved up to a combined total of CDN$200,000 in cash
bonuses to be paid to executives in respect of 2005. In determining bonuses, the
Committee considers profitability, as well as development growth, sales and
customer growth, implementation of Zi product to its customers and individual
effort in overall corporate development.



60

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The Board believes that
employees should have a stake in the future of the Corporation and that their
interests should be aligned with the interest of the Corporation's shareholders.
To this end, the Committee selects those executives and key employees whose
decisions and actions can most directly impact business results to participate
in the Stock Option Plans. Under the Stock Option Plans, officers and key
employees who are selected to participate are eligible to receive stock options
that may be granted subject to a vesting period proposed by the Compensation
Committee and approved by the Board to create a long-term incentive to increase
shareholder value. Awards of stock options and RSUs are supplementary to the
cash incentive plan and are intended to increase the pay-at-risk component for
officers and key employees. No RSUs have been issued as at March 23, 2007 in
respect of 2006 incentive compensation.



We have employment
agreements or remuneration arrangements with all of our executive officers. Each
agreement or arrangement provides for salary, benefits and bonuses for the
executive officer, and for compensation if his or her employment is terminated.
Many such agreements or arrangements provide for incentive stock option grants.
For information regarding the employment agreements of the Named Executive
Officers, see *Item 6 - Compensation of Executive Officers*. Except as
described herein, there are no agreements or other remuneration arrangements
with any of our directors.



*Corporate Governance Committee*



During 2006, the Corporate
Governance Committee consisted of Howard Balloch, as Chairman, Thompson
MacDonald and Richard Tingle. Messrs. Balloch and MacDonald ceased serving on
the Corporation's Board of Directors on December 22, 2006. The Corporate
Governance Committee currently consists of two members: Richard Tingle, as
Chairman, and Donald Hyde. The Corporation has adopted a charter for this
committee. Pursuant to its charter, the Corporate Governance Committee takes
responsibility for preparing the disclosure in the Company's Information
Circular concerning corporate governance, and for developing and monitoring the
Corporation's general approach to corporate governance issues as they arise. It
also assumes responsibility for assessing current members and nominating new
members to the Board of Directors and ensuring that all board members are
informed of and are aware of their duties and responsibilities as a director of
the Corporation. The Corporate Governance Committee takes responsibility for the
adoption of adequate policies and procedures to allow the Corporation to meet
its continuous disclosure requirements, manage the principal risks of the
Corporation, review the strategic plan on a timely basis, develop and monitor
corporate policies relating to trading in securities, ensuring the Board
annually reviews organizational structure and succession planning, reviews areas
of potential personal liability of directors and ensures reasonable protective
measures are in place and causes the Board to annually review its definition of
an unrelated director. The Committee met formally twice in 2006 and, in view of
its size, communicated informally from time to time.



D.Employees.



As of February 28, 2007, we
had 77 regular, full-time employees:



|**ZI TECHNOLOGY**          
|---------------------------
|                           
|Sales & Marketing          
|Technical                  
|Admin/Corp                 
|**ZI TECHNOLOGY
    TOTAL**



61

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We believe that our future
success will depend on our continued ability to attract and retain highly
skilled and qualified employees. None of our employees are represented by a
collective bargaining agreement. At December 31, 2006 we had 78 regular, full
time employees; at December 31, 2005, we had 78 regular, full time employees; at
December 31, 2004, we had 109 regular, full-time employees; and at December 31,
2003, we had 104 regular, full-time employees;. We believe we enjoy good
relationships with our employees.



E.Share ownership.



(a)  Share and Option Holdings



The following table sets
forth the direct and indirect actual common share ownership and option holdings
of our directors and previously Named Executive Officers (including those who
have ceased to serve during the course of 2006) at March 23, 2007.



|**Name**             | **Number of Shares 
    Beneficially Owned**(1) | **Percentage 
    of****Class**(2) | ****
|-------------------- | ----------------------------------------------- | ---------------------------------- | ----
|Michael E. Lobsinger | 5,732,113(3)                                    | 12.0                               | %   
|Derrick R. Armstrong | 387,395(4)                                      | *                                  |     
|H. Donald Hyde       | 224,995(5)                                      | *                                  |     
|Donald P. Moore      | 175,195(6)                                      | *                                  |     
|Richard D. Tingle    | 174,995(7)                                      | *                                  |     
|Milos Djokovic       | 520,000(8)                                      | 1.1                                | %   
|Robert P. Stefanski  | 12,500(9)                                       | *                                  |     
|Roland Williams      | 80,250(10)                                      | *                                  |     
|Axel Bernstorff      | 16,666(11)                                      | *                                  |     
|Blair Mullin         | Nil(12)                                         | Nil                                |     
|Howard Balloch       | 62,845(13)                                      | *                                  |     
|Thompson MacDonald   | 12,495(13)                                      | *                                  |     
|Michael Mackenzie    | 200,000(13)                                     | *                                  |     

* Indicates less than 1%

**Notes:**

(1)    Includes options and RSUs exercisable
within 60 days of March 23, 2007. Except as noted to the contrary, in notes 1 to
11 below all grant prices are expressed in Canadian dollars.



(2)   Based upon the
46,756,119 outstanding common shares, as of March 23, 2007.



(3)  In the case of
Mr. Lobsinger, this comprises 2,769,613 common shares held directly or
beneficially by Mr. Lobsinger, 3,000,000 common shares held by Quarry Bay
Investments Inc., a private Alberta corporation wholly-owned by Mr. Lobsinger,
and 950,000 share options. The share options include: 100,000 options granted
April 17, 2003 at a grant price of $2.56 and expire on April 17, 2008; 100,000
options granted on June 11, 2003 at a grant price of $3.43 and expire on June
11, 2008; 400,000 options granted March 25, 2004 at a grant price of $3.60 and
expire March 25, 2009; 50,000 options granted September 16, 2004 at a grant
price of $2.60 and expire September 16, 2009; 150,000 options granted July 21,
2005 at a grant price of $3.22 and expire on July 21, 2010; 100,000 options
granted April 4, 2006 at a grant price of $2.01 and expire on April 3, 2011,
and; 50,000 options granted January 10, 2007 at a grant price of $1.96 and
expire on January 10, 2012.



(4)  In the case of
Mr. Armstrong, this comprises 194,900 common shares held directly or
beneficially by Mr. Armstrong and 192,495 share options and RSUs. This does not
include 10,000 common shares held pursuant to a spousal registered retirement
savings plan. The share options include: 30,000 options granted June 11, 2003 at
a grant price of $3.43 and expire on June 11, 2008, 50,000 options granted
September 16, 2004 at a grant price of $2.60 and expire on September 16, 2009,
and; 50,000 options granted May 26, 2005 at a grant price of $3.64 and expire
May 26, 2010; 50,000 options granted April 4, 2006 at a grant price of $2.01 and
expire on April 3, 2011, and; 12,495 RSUs
at a grant price of nil and expire on April 3, 2011.

62

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(5) In the case of Mr. Hyde,
this comprises 12,495 common shares held directly or beneficially by Mr. Hyde
and 250,000 share options: 50,000 options granted June 11, 2003 at a grant price
of $3.43 and expire on June 11, 2008, 50,000 options at a grant price of $2.60
and expire on September 16, 2009, and; 50,000 options granted May 26, 2005 at a
grant price of $3.64 and expire on May 26, 2010; 50,000 options granted April 4,
2006 at a grant price of $2.01 and expire on April 3, 2011, and; 50,000 options
granted January 10, 2007 at a grant price of $1.96 and expire on January 10,
2012.



(6)  In the case of
Mr. Moore, this comprises 12,695 common shares held directly or beneficially by
Mr. Moore and 200,000 share options. The share options include: 50,000 options
granted September 16, 2004 at a grant price of $2.60 and expire on September 16,
2009, and; 50,000 options granted May 26, 2005 at a grant price of $3.64 and
expire on May 26, 2010; 50,000 options granted April 4, 2006 at a grant price of
$2.01 and expire on April 3, 2011, and; 50,000 options granted January 10, 2007
at a grant price of $1.96 and expire on January 10, 2012.



(7)  In the case of
Mr. Tingle, this comprises 212,495 share options and RSUs which include: 50,000
options granted January 5, 2005 at a grant price of $7.79 and expire on January
5, 2010 and; 50,000 options granted May 26, 2005 at a grant price of $3.64 and
expire on May 26, 2010; 50,000 options granted April 4, 2006 at a grant price of
$2.01 and expire on April 3, 2011;12,495 RSUs at a grant price of nil, and;
expire on April 3, 2011 and 50,000 options granted January 10, 2007 at a grant
price of $1.96 and expire on January 10, 2012.



(8) In the case of Mr.
Djokovic, this comprises 920,000 share options which include: 230,000 options
granted October 26, 2004 at a grant price of U.S.$3.40 and expire October 26,
2009, and; 90,000 options granted July 21, 2005 at a grant price of $3.22 and
expire July 21, 2010; 200,000 options granted April 4, 2006 at a grant price of
$2.01 and expire on April 3, 2011, and; 400,000 options granted February 28,
2007 at a grant price of $2.43 and expire on February 28, 2012.



(9) In the case of Mr.
Stefanski, this comprises 50,000 share granted January 10, 2007 at a grant price
of $1.96 and expire on January 10, 2012.



(10) In the case of Dr.
Williams, this comprises 130,250 share options which include: 6,500 options
granted March 25, 2004 at a grant price of $3.60 and expire March 25, 2009;
13,750 options granted March 17, 2005 at a grant price of $5.60 and expire March
17, 2008; 10,000 options granted July 21, 2005 at a grant price of $3.22 and
expire July 21, 2010; 50,000 options granted April 4, 2006 at a grant price of
$2.01 and expire April 3, 2011; and, 50,000 options granted September 6, 2006 at
a grant price of $0.99 and expire September 6, 2011



(11) In the case of Mr.
Bernstorff, this comprises 120,000 share options which include: 10,000 options
granted August 30, 2005 at a grant price of $2.73 and expire August 30, 2010;
10,000 options granted April 4, 2006 at a grant price of $2.01 and expire April
3, 2011; and, 100,000 options granted September 15, 2006 at a grant price of
$0.96 and expire September 15, 2011



(12) In the case of Mr. Mullin, to date no options have been granted.



(13) As of March 23, 2007,
such individual is no longer a director or officer of the Corporation, and
therefore the number of shares stated as being beneficially owned by such
individual is based on the Corporation's best knowledge.



(b)Option Plans



*Purpose of Plans*



The purpose of the Plans is
to advance the interests of the Corporation or any of its subsidiaries or
affiliates by encouraging the directors, officers, employees and consultants to
acquire shares in the Corporation, thereby increasing their proprietary interest
in the Corporation, encouraging them to remain associated with the Corporation
or any of its subsidiaries or affiliates and furnishing them with additional
incentive in their efforts on behalf of the Corporation or any of its
subsidiaries or affiliates.



63

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*Eligibility*



The Plans provide for the
issuance of options ("Options") and RSUs exercisable to acquire common shares of
the Corporation to directors, officers, employees and consultants, including a
personal holding Corporation controlled by one of the aforementioned
participants, a participant's spouse, children and/or grandchildren and a
consulting corporation engaged to provide ongoing consulting services for the
Corporation or any of its subsidiaries or affiliates. Options and/or RSUs may be
granted, either alone or in addition to, in tandem with or in substitution for
any other Options or RSUs previously granted. The specific terms of each Option
are provided in a separate Option Agreement ("Option Agreement"), and the
specific terms of each RSU are provided in a separate Restricted Stock Unit
Agreement ("RSU Agreement").



RSUs are notional credits
maintained on the books of the Corporation; the value of each RSU reflects the
value of one common share and entitles the holder to receive one common share
from the treasury of the Corporation. Each RSU granted to participants will be
subject to individual terms specified by the Committee in the RSU Agreement,
including the time or times at which the RSU may be exercised.



The number of common shares
that may be issued under the Plans is subject to appropriate adjustment in the
event of certain corporate transactions or events.



*Administration of the Plans*



The Plans are administered
by the Board, or if appointed, a special committee of directors appointed by the
Board (such a special committee or the Board, if no special committee is
appointed, is referred to herein as the "Committee"), whose members have
responsibility for designating participants under the Plans and, subject to the
terms of the Plans, for setting the terms of Options and RSUs. Unless otherwise
expressly provided in the Plans, all designations, determinations,
interpretations and other decisions under or with respect to the Plans or any
Option or RSU shall be within the sole discretion of the Committee, may be made
at any time and shall be final, conclusive and binding upon any participant, any
holder or beneficiary of any Option or RSU. In determining which eligible
persons shall receive an Option or RSU and the terms of any Option or RSU, the
Committee may take into account the nature of the services rendered by the
respective person, his or her present and potential contributions to the success
of the Corporation or such other factors as the Committee, in its discretion,
deems relevant. If the Board appoints a special committee to serve as the
Committee, the Board may from time to time increase and thereafter decrease the
size of such special committee and may fill any vacancies however created.



*Amendment of the Plans*



Subject to any required approval of any stock
exchange on which the Corporation's securities are listed, the Board reserves
the right to amend, suspend or terminate the Plans at any time if and when it is
advisable in the absolute discretion of the Board or Committee; provided
however, no such amendment or revision shall alter the terms of any Options or RSUs theretofore granted under the Plans.



*Necessary Approvals*



The ability of the Options
or RSUs to be exercised and the obligation of the Corporation to issue and
deliver shares in accordance with the Plans is subject to any approvals that may
be required from the shareholders of the Corporation, or any regulatory
authority or stock exchange having jurisdiction over the securities of the
Corporation.



*Adjustment in Shares Subject to the Plan*



Other than dividends
declared in the normal course, appropriate adjustments in the number of common
shares optioned, in the option price per share, as regards Options granted or to
be granted, and in the RSUs granted or to be granted, may be made by the
Committee in its discretion to give effect to adjustments in the number of
common shares of the Corporation resulting subsequent to the approval of the
Plans by the Committee from subdivisions, consolidations or reclassification of
the common shares of the Corporation, the payment of stock dividends by the
Corporation or other relevant changes in the capital of the Corporation.



64

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The number of common shares
that may be issued under the Plans is subject to appropriate adjustment in the
event of certain corporate transactions or events.



Options provide the holder
with the right to purchase common shares at a stated exercise price before a
specified date in the future. The exercise price for Options shall not be less
than the price permitted by any stock exchange on which the Shares are then
listed or other regulatory body having jurisdiction. The exercise price of
Options granted under the Plans must be equal to not less than 100 percent of
the fair market value of the common shares on the date of grant, which shall be
determined based on the closing price for board lots of common shares listed on
the Toronto Stock Exchange on the last day of trading immediately preceding the
date of the grant.



A comparative chart
highlighting the significant terms of each of the Plans is as follows:



|                                                       |  | **1993**
    **Plan**                                                                                                    |  | **1995**
    **Plan**                                                                                                |  | **1996**
    **Plan**                                                                                                |  | **1998**
    **Plan**                                                                                                |  | **1999**
    **Plan**
    **(as amended in
    2000 and 2002)**                                                     
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------------ |  | -------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------
|**Eligible
    participants**                          |  | Directors, officers,
    employees, consultants and their associates.                                                    |  | Directors, officers,
    employees, consultants and their associates.                                                |  | Directors, officers,
    employees, consultants and their associates.                                                |  | Directors, officers,
    employees, consultants and their associates.                                                |  | Directors, officers,
    employees, consultants and their associates.                                               
|**Number of
    securities issued/issuable**           |  | Not to exceed the
    maximum number of shares permitted under the rules of any regulatory body
    having jurisdiction. |  | Not to exceed 1,430,000
    common shares.                                                                           |  | Not to exceed 2,600,000
    common shares.                                                                           |  | Not to exceed 1,300,000
    common shares.                                                                           |  | Not to exceed 4,960,000
    common shares and 500,000 RSUs.                                                         
|**Maximum
    percentage available to insiders**       |  | Not to exceed the
    maximum number of shares permitted under the rules of any regulatory body
    having jurisdiction. |  | Not to exceed 10% of the
    outstanding issue.                                                                      |  | Not to exceed 10% of the
    outstanding issue.                                                                      |  | Not to exceed 10% of the
    outstanding issue.                                                                      |  | Not to exceed 10% of the
    outstanding issue.                                                                     
|**Maximum number
    of securities to any one entity** |  | Not to exceed the
    maximum number of shares permitted under the rules of any regulatory body
    having jurisdiction. |  | Not to exceed 5% of the
    outstanding issue.                                                                       |  | Not to exceed 5% of the
    outstanding issue.                                                                       |  | Not to exceed 5% of the
    outstanding issue.                                                                       |  | Not to exceed 5% of the
    outstanding issue.                                                                      
|**Method for
    determining the exercise price**      |  | Determined by the Board
    or Committee, but shall not be less than the price permitted by any
    regulatory body.     |  | Determined by the Board
    or Committee, but shall not be less than the price permitted by any
    regulatory body. |  | Determined by the Board
    or Committee, but shall not be less than the price permitted by any
    regulatory body. |  | Determined by the Board
    or Committee, but shall not be less than the price permitted by any
    regulatory body. |  | Determined by the Board
    or Committee, but shall not be less than the price permitted by any
    regulatory body.



65

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|**Method for
    determining the purchase price** |  | Determined by the Board
    or Committee at the time any option is granted but shall not be lower than
    the Market Price. |  | Determined by the Board
    or Committee at the time any option is granted but shall not be lower than
    the Market Price. |  | Determined by the Board
    or Committee at the time any option is granted but shall not be lower than
    the Market Price. |  | Determined by the Board
    or Committee at the time any option is granted but shall not be lower than
    the Market Price. |  | Determined by the Board
    or Committee at the time any option is granted but shall not be lower than
    the Market Price.
|------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------
|**Vesting of stock
    options**                  |  | Determined by the Board
    or Committee.                                                                                    |  | Determined by the Board
    or Committee.                                                                                    |  | Determined by the Board
    or Committee.                                                                                    |  | Determined by the Board
    or Committee.                                                                                    |  | Determined by the Board
    or Committee.                                                                                   
|**Term of stock
    options**                     |  | Fixed by the Board or
    Committee.                                                                                         |  | Fixed by the Board or
    Committee, subject to a 10 year maximum.                                                           |  | Fixed by the Board or
    Committee, subject to a 10 year maximum.                                                           |  | Fixed by the Board or
    Committee, subject to a 10 year maximum.                                                           |  | Fixed by the Board or
    Committee, subject to a 10 year maximum.                                                          
|**Causes of
    cessation of entitlement**        |  | Resignation of
    Participant status or death.                                                                              |  | Resignation of
    Participant status or death.                                                                              |  | Resignation of
    Participant status or death.                                                                              |  | Resignation of
    Participant status or death.                                                                              |  | Resignation of
    Participant status or death.                                                                             
|**Assignability**                                 |  | Not transferable or
    assignable.                                                                                          |  | Not transferable or
    assignable.                                                                                          |  | Not transferable or
    assignable.                                                                                          |  | Not transferable or
    assignable.                                                                                          |  | Not transferable or
    assignable.                                                                                         
|**Procedure for
    amending**                    |  | Subject to regulatory
    approval, the Committee or Board may suspend, terminate, amend or revise the
    Plan.             |  | Subject to regulatory
    approval, the Committee or Board may suspend, terminate, amend or revise the
    Plan              |  | Subject to regulatory
    approval, the Committee or Board may suspend, terminate, amend or revise the
    Plan.             |  | Subject to regulatory
    approval, the Committee or Board may suspend, terminate, amend or revise the
    Plan.             |  | Subject to regulatory
    approval, the Committee or Board may suspend, terminate, amend or revise the
    Plan.            



Item 7.  Major Shareholders and Related Party Transactions



A.Major shareholders.



To the knowledge of the
Company, the following table sets forth the names of each of the persons or
entities who beneficially hold, directly or indirectly, or exercise control or
direction over more than five percent (5%) of the voting rights attached to the
issued and outstanding shares of the Company entitled to vote at the shareholder
meetings of the Company as at March 23, 2007.



|**Name and
    municipality**                       | **Beneficial number**
    **of shares held** | **Percentage of total**
    **voting rights**
|--------------------------------------------------- | -------------------------------------------- | ---------------------------------------------
|Marty Steinberg,
    Receiver(1)
    Miami, Florida | 18,718,000                                   | 40.0%(3)                                     
|Michael E. Lobsinger(2)
    Calgary, Alberta        | 4,819,613                                    | 10.3%(3)                                     



66

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**Notes:**



(1)
      Marty Steinberg has represented to the
      Corporation that he is the court appointed Receiver of Lancer Management
      Group LLC, and related entities to Lancer Management Group LLC and
      responsible person for other related parties that are currently debtors in
      possession under a Chapter 11 case pending before United States courts.
      Marty Steinberg is a lawyer with and represented by the law firm Hunton &
      Williams LLP of Miami, Florida. The information provided herein is based
      upon filings made on the SEDI insider trading reporting system in Canada
      and on a Schedule 13D (the "Schedule 13D") filed on December 11, 2003 with
      the SEC by Marty Steinberg, Esq., as Receiver (the "Receiver") of Lancer
      Management Group, LLC, Lancer Management Group II, LLC, Lancer Offshore,
      Inc., Lancer Partners, LP, LSPV, Inc., LSPV, LLC, Omnifund, Ltd, G.H.
      Associates, Inc., and Alpha Omega Group (the "Receivership Entities"). In
      the Schedule 13D the Receiver states that due to the poor condition of the
      records of the Receivership Entities he does not represent the
      truthfulness or accuracy of the Schedule 13D and the Corporation takes no
      responsibility for the information provided herein based on the Schedule
      13D. The Schedule 13D was amended on February 27, 2007.




(2)
      Of
      which 1,819,613 common shares are held directly or beneficially by
      Mr. Lobsinger and 3,000,000 are held by Quarry Bay Investments Inc., a
      private Alberta corporation wholly-owned by Mr. Lobsinger.




(3)
      The
      Company's major shareholders hold common shares, which shares do not carry
      different voting rights than any other shares, except as limited by the
      Alberta Court's ruling in the case of the Receiver. As a result of
      attempts by the Receiver to effect a replacement of the members of the Zi
      Board of Directors, the Alberta Court had issued an interim injunction
      that prohibits the Receiver from requisitioning a special meeting of the
      Corporation's shareholders for the purpose of voting its shares in support
      of its proposed slate 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




Based on a report from
Olympia Trust Company, as at December 31, 2006, there were 170 registered
shareholders in the United States that held 25,868,377 common shares or 55.4
percent of the common shares outstanding.



To the extent known to the
Company, the Company is not directly or indirectly owned or controlled by any
foreign government, or by any other natural or legal persons, severally or
jointly.



The Company is not aware of
any arrangements the operation of which may at a subsequent date result in a
change in control of the Company.



B.Related party
transactions.



Except as set forth below
and other than employment agreements with executive officers, stock option
grants described elsewhere in this report or as otherwise disclosed in this
report, the Company is not aware of any related party transactions occurring or
being made, or any loans made by the Company or any of its subsidiaries to
related parties, from January 1, 2006 to March 23, 2007, other than the
following:



January 1, 2007 to March
23, 2007



During the Corporation's
period from January 1, 2007 to March 23, 2007, the Corporation accrued and/or
paid legal fees to a law firm of which Derrick Armstrong was a partner
amounting, in the aggregate, to $67,461.



A consulting fee was paid by
the Corporation to a consulting firm in which Blair Mullin was a partner
amounting to $39,500 during the period from January 1, 2007 to March 23, 2007.



In February 2006, Donald P.
Moore, a director of the Corporation nominated by the Receiver, brought an
action against the Corporation and Michael Lobsinger, then the Chairman,
President and CEO of the Corporation at that time, under the Business
Corporation Act (Alberta) (the "ABCA"), claiming that the Corporation had
failed to make certain records available to him 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.



67

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The Corporation is a party to legal
proceedings with the Receiver in both Alberta and Florida, in respect of which
the parties have signed a conditional settlement agreement. The Receiver is the
holder of approximately 40 percent of the Corporation's outstanding shares. SeeItem 4  Information on the Company 
History and Development of the Company.



Various inter-company
software licenses and arrangements exist between some of the Corporation's
subsidiaries, which allow certain of the Corporation's subsidiaries to license
the Corporation's software to third parties.



January 1, 2006 to December 31, 2006



During the Corporation's fiscal year ended
December 31, 2006, the Corporation accrued and/or paid legal fees to a law firm
of which Derrick Armstrong is a partner amounting, in the aggregate, to
$158,078.



During the Corporation's
fiscal year ended December 31, 2006, the Corporation accrued and/or paid
consulting fees to a consulting firm of which Dale Kearns was an owner
amounting, in aggregate, to $34,248.



During the Corporation's
fiscal year ended December 31, 2006, the Corporation accrued and/or paid
consulting fees to a consulting firm of which Blair Mullin was a partner
amounting, in aggregate, to $66,006.



January 1, 2005 to
December 31, 2005



During the Corporation's
fiscal year ended December 31, 2005, the Corporation accrued and/or paid legal
fees to a law firm of which Derrick Armstrong was a partner amounting, in the
aggregate, to $227,883.



A consulting fee was paid by
the Corporation to a consulting firm owned by Dale Kearns amounting to $49,333
during the fiscal year ended December 31, 2005.



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.
During 2005, the Company paid fees of $760 on behalf of a significantly
influenced company.



During the Corporation's fiscal year
ended December 31, 2005, the Corporation transferred its interest in Oztime and
English Practice to Archer Education Group Inc. Michael Lobsinger and Don Hyde,
directors of the Corporation, serve as directors of Archer.



On December 30, 2005, an entity that is a related
party to Michael Lobsinger subscribed to 180,000 shares of Archer representing
1.6 percent of its outstanding shares at December 31, 2005.



January 1, 2004 to
December 31, 2004



During the Corporation's
fiscal year ended December 31, 2004, the Corporation accrued and/or paid legal
fees to a law firm of which Derrick Armstrong was a partner amounting, in the
aggregate, to $125,708.



A management fee was paid by
the Corporation to a consulting firm owned by Dale Kearns amounting to $46,067
during the fiscal year ended December 31, 2004.



A management fee was paid by
the Corporation to a consulting firm owned by Howard Balloch amounting to
$30,000 during the fiscal year ended December 31, 2004.



68

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C.Interests of experts
and counsel.



Not applicable.



Item 8. Financial Information



A.Consolidated Statements and Other Financial Information.



See *Item 18 - Financial
Statements*.



Legal Proceedings



To our knowledge, the
material legal proceedings related to the Company are as follows:



Certain of our customers
have been subject to a patent infringement claim in the People's Republic of
China as described below**.**While we have not been made party to
the claims, these customers have executed licenses with the Company for the use
of eZiText on their products, which licenses contain third party intellectual
property infringement indemnities. As a result, these claims may have
significant consequences for the Company to the extent that such claims may
relate to the implementation and use of eZiText on products sold in the People's
Republic of China and to the extent that our indemnity under our license
agreement may be applicable.



|*(i)* | *Dalian Hanpu Applied Technology Co., Ltd., Hu
    Xianhua & Hu Bin v. Ericsson (China) Co., Ltd. and Beijing Ericsson Mobile
    Telecommunication Co., Ltd., (the "First Dalian Ericsson Action").*The First Dalian Ericsson Action is in
    the Higher People's Court (the "High Court") in Beijing, China. The High
    Court served Beijing Ericsson Mobile Telecommunication Co., Ltd. on
    August 16, 2000, and Ericsson (China) Co., Ltd. with the plaintiffs'
    complaint on August 17, 2000. The complaint alleges that Ericsson (China)
    Co. Ltd. and Beijing Ericsson Mobile Telecommunication Co., Ltd. infringed
    the plaintiffs' intellectual property rights, namely Chinese patent
    ZL96120693.4, "Keyboard Assignment of Stroke Input and its Screen Prompt."
    On August 18, 2000, Ericsson sent Zi Corporation a request for
    indemnification pursuant to the license agreement between Ericsson Mobile
    Communications AB and Zi Corporation of Canada, Inc. The Company and its
    affiliates have not been named as a party in the First Dalian Ericsson
    Action.
|----- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|*(ii)* | *Dalian Hanpu Applied Technology Co., Ltd., Hu
    Xianhua & Hu Bin v. Ericsson (China) Co., Ltd. and Nanjing Ericsson Panda
    Mobile Terminals Co., Ltd., (the "Second Dalian Ericsson (Panda) Action").*The Second Dalian Ericsson
    (Panda) Action is in the Second Intermediate People's Court (the "Lower
    Court") in Beijing, China. This is a lower court than the High Court in
    which the First Dalian Ericsson Action is being tried. The plaintiffs'
    complaint was filed with the Lower Court on February 22, 2001. This
    complaint alleges that Ericsson (China) Co., Ltd. and Nanjing Ericsson Panda
    Mobile Terminals Co., Ltd. infringed the plaintiffs' intellectual property
    rights, namely Chinese patent ZL96120693.4, "Keyboard Assignment of Stroke
    Input and its Screen Prompt" (the same patent under suit in the First Dalian
    Ericsson Action). On February 22, 2001, Ericsson sent Zi Corporation a
    request for indemnification pursuant to the Ericsson Chinese License
    Agreement (defined below). The Company and its affiliates have not been
    named as a party in the Second Dalian Ericsson (Panda) Action. A ruling in
    Ericsson's favour was issued by the Lower Court on this matter on May 23,
    2002. The Lower Court rejected the plaintiff's claims of infringement
    finding that: (1) there was no literal infringement of the plaintiff's
    patent by Zi's input technology on the Ericsson phone models in dispute; and
    (2) the doctrine of equivalence argued by the plaintiff could not be
    accepted as it would broaden the original scope of the plaintiff's patent
    claims. The plaintiff was charged with paying a nominal amount of RMB1,000
    to cover case handling fees. The plaintiff has filed a notice of appeal to
    the High Court in order to appeal this Lower Court ruling. To the Company's
    knowledge, Ericsson is defending this appeal.
|------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Both claims described in (i)
and (ii) above will be collectively referred to as the "Ericsson/HuBin Claims"
and the Ericsson parties named in the Ericsson/HuBin Claims shall be referred to
as "Ericsson". Under the respective notices sent to us, Ericsson asserted its
rights to indemnification granted by us to Ericsson under our Chinese eZiText
license agreement with Ericsson signed February 17, 1998 (the "Ericsson Chinese
License Agreement"). Pending determination of the actual scope of the alleged
infringement and whether the scope of indemnity provided under the Ericsson
Chinese License Agreement applies, we have taken a course of action where we pay
for Ericsson's legal fees and where we exercise sole control of the conduct of
Ericsson's defense against the Ericsson/HuBin Claims. Ericsson is cooperating
and participating with Zi to defend against the Ericsson/HuBin Claims. We
believe that the allegations are unfounded and without merit and Zi and Ericsson
are vigorously defending against the Hu Bin claims.



69

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Furthermore, Ericsson made a
separate application to the PRC Patent Office seeking invalidation of the HuBin
Patent (the "Invalidation Application"). An invalidation hearing was held with
the PRC Patent Re-examination Board on May 27, 2002. In March 2004, a ruling
from the PRC Patent Re-examination Board was rendered in favour of the patent.
An appeal was heard in October 2004 and Ericsson was successful on most counts.
As a result, certain portions of the Hu Bin patent were found to be invalid.
This ruling is currently under appeal. We are awaiting advice with respect to
the status of this appeal. We have been informed by our attorneys that, on March
2, 2005, the High Court issued an administrative ruling to suspend the
proceedings of the Ericsson/HuBin Claims, in light of the fact that a final
decision has not yet been made in respect of the Invalidation Application, and
our attorneys believe that it is unlikely for such proceedings to resume prior
to a final decision being made on the Invalidation Application.



|*(iii)* | *Dalian Hanpu Applied
    Technology Co., Ltd., Hu Xianhua & Hu Bin v. Alcatel Suzhou communication
    Co., Ltd and Another (the "Dalian Alcatel Action").*
    On April 5, 2001, the Company received a
    notice from Alcatel Suzhou Communication Co., Ltd. that Alcatel Suzhou
    Communication Co., Ltd, and Yanshaqiro Trading Branch of Beijing Yingcong
    Science and Trade Center have been made parties to a patent infringement
    claim in the PRC (the "Alcatel/Hu Bin Claims") filed in the Lower Court for
    infringement of Chinese patent ZL96120693.4 (the same patent in both of the
    First Dalian Ericsson Action and the Second Dalian Ericsson (Panda) Action).
    On April 19, 2001, Alcatel sent Zi Corporation of Canada, Inc. a request for
    indemnification pursuant to the license agreement between Alcatel Business
    Systems and Zi Corporation of Canada, Inc. Zi responded on May 8, 2001
    denying the applicability of the indemnity and we have not received any
    answering response from Alcatel. The Company and its affiliates have not
    been named as a party in the Dalian Alcatel Action.
|------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



A ruling in Alcatel's favour
on this matter was also issued by the Lower Court on May 23, 2002. The rulings
by the Lower Court in this Dalian Alcatel Action are substantially similar to
those given in the Second Dalian Ericsson (Panda) Action. The plaintiff has
filed a notice of appeal to the High Court in order to appeal this Lower Court
ruling. To the Company's knowledge, Alcatel is defending this appeal.



We have disputed the
applicability of the indemnity provided by us to Alcatel under the license
agreement dated October 20, 1999 (the "Alcatel License Agreement") in respect of
the Alcatel/HuBin Claims. To date, we are not providing any indemnification to
Alcatel in respect of Alcatel's defense of the Alcatel/Hu Bin claim; however, we
have been actively providing Alcatel technical support for their defense. The
Company believes that the Dalian Alcatel Action has been suspended in light of
the fact that a final decision has not yet been made in respect of the
Invalidation Application.



|(iv) | 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 (the "'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.
    
    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, as a business decision, the Company settled the claims against
    four of the Company's relatively minor customers.  The Company continues to
    defend the action on behalf of one of its customers.
    
    Simultaneously, the world's second largest provider of mobile phones and the
    Company's principal competitor are seeking  reexamination of the '112 Patent
    in the US Patent & Trademark Office.
    
    It
    is the Company's position that its product or products on a standalone basis
    does not infringe the '112 Patent.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



70

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|(v) | The Corporation is a party to legal proceedings with the Receiver
    in both Alberta and Florida, in respect of which the parties have signed a
    conditional settlement agreement. The Receiver is the holder of
    approximately 40 percent of the Corporation's outstanding shares. SeeItem
    4  Information on the Company  History and Development of the Company.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Dividend Policy



To date, we have not paid
any dividends on shares, and do not anticipate doing so in the foreseeable
future. The declaration of dividends on our common shares is within the
discretion of our Board of Directors and will depend upon, among other factors,
earnings, capital requirements, and the operating and financial condition of the
Company.



B.Significant Changes.



Not applicable.



Item 9. The Offer and Listing.



A.Offer and listing details  Stock Price History



Our common shares are traded
on the Toronto Stock Exchange under the symbol "ZIC" and on the NASDAQ Global
Market under the symbol "ZICA". The following tables set forth, for the periods
indicated, high and low sale prices of our common shares as reported on the
Toronto Stock Exchange and on the NASDAQ Global Market.



**Toronto Stock
Exchange (in CDN$):**



|**Period**                           |  | **High** |       | Low
|------------------------------------ |  | -------- | ----- | ---
|February 2007                        |  | $        | 3.20  |    
|January 2007                         |  | $        | 2.75  |    
|December 2006                        |  | $        | 2.99  |    
|November 2006                        |  | $        | 1.38  |    
|October 2006                         |  | $        | 1.27  |    
|September 2006                       |  | $        | 1.40  |    
|Quarter ended December
    31, 2006  |  | $        | 2.99  |    
|Quarter ended September
    30, 2006 |  | $        | 1.78  |    
|Quarter ended June 30,
    2006      |  | $        | 2.13  |    
|Quarter ended March 31,
    2006     |  | $        | 2.78  |    
|Quarter ended
    December 31, 2005  |  | $        | 3.49  |    
|Quarter ended
    September 30, 2005 |  | $        | 3.81  |    
|Quarter ended June 30,
    2005      |  | $        | 5.08  |    
|Quarter ended March 31,
    2005     |  | $        | 9.15  |    
|Year ended December 31,
    2006     |  | $        | 2.99  |    
|Year ended December 31,
    2005     |  | $        | 9.15  |    
|Year ended December 31,
    2004     |  | $        | 8.69  |    
|Year ended December 31,
    2003     |  | $        | 5.60  |    
|Year ended December 31,
    2002     |  | $        | 11.29 |    



71

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****

**NASDAQ (in U.S.$):**

|                                     |  |          |      |        
|------------------------------------ |  | -------- | ---- | -------
|**Period**                           |  | **High** |      | **Low**
|February 2007                        |  | $        | 2.73 |        
|January 2007                         |  | $        | 2.32 |        
|December 2006                        |  | $        | 2.85 |        
|November 2006                        |  | $        | 1.22 |        
|October 2006                         |  | $        | 1.13 |        
|September 2006                       |  | $        | 1.23 |        
|Quarter ended December
    31, 2006  |  | $        | 2.85 |        
|Quarter ended September
    30, 2006 |  | $        | 1.57 |        



|Quarter ended June 30,
    2006      |  | $ | 1.85 |  | $ | 1.00
|------------------------------------ |  | - | ---- |  | - | ----
|Quarter ended March 31,
    2006     |  | $ | 2.44 |  | $ | 1.42
|Quarter ended
    December 31, 2005  |  | $ | 4.08 |  | $ | 1.32
|Quarter ended
    September 30, 2005 |  | $ | 7.04 |  | $ | 2.14
|Quarter ended June 30,
    2005      |  | $ | 9.44 |  | $ | 2.17
|Quarter ended March 31,
    2005     |  | $ | 7.45 |  | $ | 3.96
|Year ended December 31,
    2006     |  | $ | 2.85 |  | $ | 0.66
|Year ended December 31,
    2005     |  | $ | 7.45 |  | $ | 1.32
|Year ended December 31,
    2004     |  | $ | 7.55 |  | $ | 2.00
|Year ended December 31,
    2003     |  | $ | 4.08 |  | $ | 1.62
|Year ended December 31,
    2002     |  | $ | 7.04 |  | $ | 2.27



B.Plan of distribution.



Not applicable.



C.Markets.



Our common shares are listed on the Toronto Stock
Exchange and NASDAQ Global Market. At December 31, 2006, the Company had
46,688,624 common shares with no par value outstanding.



D.Selling shareholders



Not applicable.



E.Dilution.



Not applicable.



F.Expenses of the
issue.



Not applicable.



Item 10. Additional Information.



A.Share capital.



Not applicable.

72

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B.Memorandum and
articles of association.



The Company's Certificate of
Incorporation, together with all amendments, which we refer to as our articles
of incorporation, are on file with the Alberta Registrar of Corporations under
Alberta Corporate Access Number 203761614. Our articles of incorporation do not
include a stated purpose and contain no restrictions on the nature of business
to be carried on. Under the Alberta *Business Corporations Act*, in the
absence of any such restrictions, a corporation has the capacity, rights, powers
and privileges of a natural person, and has the capacity to carry on business,
conduct its affairs and exercise its power in any jurisdiction outside Alberta
to the extent that the laws of that jurisdiction permit. For additional
information regarding our incorporation, see *Item 4 - Information on the
Company - History and Development of the Company*.



*Directors*



A director of our Company
need not be a shareholder. In accordance with the Alberta *Business
Corporations Act*, at least 25 percent of our directors must be residents of
Canada. The Alberta *Business Corporations Act* requires that a person
must be at least 18 years of age, be of sound mind and not be bankrupt or a
dependent adult or formal patient under the *Dependent Adults Act* or *Mental Health Act*, or the subject of an order under *The Mentally
Incapacitated Persons Act* in order to serve as a director. Neither our
articles of incorporation or by-laws, nor the Alberta *Business Corporations
Act*, impose any mandatory retirement requirements for directors.



A majority of the lesser of
the number of directors holding office at the time of the meeting and the
minimum number of directors required by our articles of incorporation will
constitute a quorum, provided that at least one quarter of the directors present
are resident Canadians. Business cannot be transacted at a directors' meeting
without a quorum.



A director who is a party
to, or who is a director or officer of or has a material interest in any person
who is a party to, a material contract or transaction or proposed material
contract or transaction with our Company shall disclose to the Company the
nature and extent of his interest at the time and in the manner provided by the
Alberta *Business Corporations Act*. The Alberta *Business
Corporations Act* prohibits such a director from voting on any resolution to
approve the contract or transaction unless the contract or transaction:



§is an arrangement by way of
security for money lent to or obligations undertaken by the director for the
benefit of the Company or an affiliate;

§relates primarily to his or her
remuneration as a director, officer, employee or agent of the Company or an
affiliate;

§is for indemnity or insurance; or

§is with an affiliate.





Our Board of Directors may,
on behalf of the Company and without authorization of our shareholders:



§borrow money upon the credit of the
company;

§issue, reissue, sell or pledge
bonds, debentures, notes or other evidences of indebtedness or guarantees of our
company, either secured or unsecured;

§subject to certain disclosure
requirements of the Alberta *Business Corporations Act*, give a guarantee
on behalf of our Company to secure performance of an obligation of any person;

§mortgage, hypothecate, pledge or
otherwise create a security interest in all or any property of the Company owned
or subsequently acquired to secure any obligation of the Company; and

§issue common shares or other
securities of the Company.



Our articles of
incorporation permit our Board of Directors to appoint one or more additional
directors of the Company to serve until the next annual meeting of shareholders,
provided that the number of additional directors does not at any time, exceed
one-third of the number of directors who held office at the expiration of the
last annual meeting of shareholders of the Company.



73

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*Common Shares*



Our articles of incorporation authorize the
issuance of an unlimited number of common shares. The holders of the common
shares of the Company are entitled to receive notice of and to attend all
meetings of the shareholders of our Company and have one vote for each common
share held at all meetings of the shareholders of the Company, except for
meetings at which only holders of another specified class or series of shares of
the Company are entitled to vote separately as a class or series.



Subject to the prior rights
of the holders of preferred shares of the Company, the holders of common shares
are entitled to receive dividends if and when declared by our Board of
Directors.



In the event of the
dissolution, liquidation or winding-up of the Company and subject to the prior
rights of the holders of preferred shares, the holders of the common shares will
be entitled to share equally in the remaining property and assets of the
Company.



*Preferred Shares*



Our articles of
incorporation authorize the issuance of an unlimited number of preferred shares,
in one or more series. The Alberta *Business Corporations Act* does not
impose restrictions upon our Board of Directors issuing preferred shares of the
type authorized by our articles of incorporation. Our Board of Directors may
fix, before issuing, the number of preferred shares of each series, the
designation, rights, privileges, restrictions and conditions attaching to the
preferred shares of each series, including the rate or amount of dividends or
the method of calculating dividends, the dates of payment of dividends, the
redemption purchase and/or conversion price and terms and conditions of
redemption, purchase and/or conversion and any sinking fund or other provisions,
the whole to be subject to the sending of articles of amendment in prescribed
form and the issuance of a certificate of amendment.



Our articles of
incorporation require that preferred shares of each series must, with respect to
the payment of dividends and the distribution of assets in the event of the
liquidation, dissolution or winding-up of the Company, whether voluntary or
involuntary, or any other return of capital or distribution of the assets of the
Company among its shareholders for the purpose of winding up our affairs, rank
on a parity with the preferred shares of every other series and be entitled to
preference over the common shares and over any other shares of the Company
ranking junior to the preferred shares.



If any cumulative dividends
or amounts payable on the return of capital in respect of a series of preferred
shares are not paid in full, all series of preferred shares shall participate
rateably in respect of accumulated dividends and return of capital.



The holders of preferred
shares will not be entitled to receive notice of or vote at any shareholders'
meetings, except as specifically provided by the Alberta *Business
Corporations Act*. No preferred shares are currently outstanding. There is
no present intention to issue any preferred chares.



*Changing Rights of Shareholders*



We are required to amend our
articles of incorporation to effect any change to the rights of our
shareholders. Such an amendment would require the approval of holders of
two-thirds of the shares cast at a duly called special meeting. If we wish to
amend the rights of holders of a specific class of shares, such approval would
also be required from the holders of that class. A shareholder is entitled to
dissent in respect of such a resolution and, if the resolution is adopted and
the Company implements such changes, demand payment of the fair value of its
shares.



*Shareholder Meetings*



An annual meeting of
shareholders is held each year, generally not later than 15 months after the
last preceding annual meeting, for the purpose of considering the financial
statements and reports, electing directors, appointing auditors and for the
transaction of other business as may be brought before the meeting. The Board of
Directors has the power to call a special meeting of shareholders at any time.
The By-laws of the Company provide that two persons present in person holding or
representing by proxy five percent (5%) of the issued common shares of the
Corporation, shall constitute a quorum for the meeting in respect of holders of
common shares. Although this quorum requirement is less than that imposed by the
rules of the NASDAQ Global Market System, we have operated for the past years
under an exemption from such requirement on the basis that we are a foreign
private issuer and such a quorum requirement is consistent with normal business
practices in our jurisdiction of incorporation.



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Notice of the time and place
of each meeting of shareholders must be given not less than 21 days, nor more
than 50 days, before the date of each meeting to each director, to the auditor
and to each shareholder who at the close of business on the record date for
notice is entered in the securities register as the holder of one or more shares
carrying the right to vote at the meeting. Notice of meeting of shareholders
called for any other purpose other than consideration of the minutes of an
earlier meeting, financial statements and auditor's report, election of
directors and reappointment of the incumbent auditor, must state the nature of
the business in sufficient detail to permit a shareholder to form a reasoned
judgement and must state the text of any special resolution to be submitted to
the meeting.



The only persons entitled to
be present at a meeting of shareholders are those entitled to vote, the
directors of the company and the auditor of the company. Any other person may be
admitted only on the invitation of the chairman of the meeting or with the
consent of the meeting. If a corporation is winding-up, the Alberta *Business
Corporations Act* permits a liquidator appointed by the shareholders, during
the continuance of a voluntary winding-up, to call and attend meetings of the
shareholders. In circumstances where a court orders a meeting of shareholders,
the court may direct how the meeting may be held, including the parties
entitled, or required, to attend the meeting.



Our articles of
incorporation state that meetings of our shareholders may be held in the cities
of San Francisco, California, Los Angeles, California, New York, New York and
Phoenix, Arizona in the United States of America, in Toronto, Ontario, Canada
and in Hong Kong, China and Beijing, China in addition to anywhere in the
Province of Alberta.



*Limitations on Right to Own Securities*



There is no limitation
imposed by Canadian law or by our articles or other charter documents on the
right of a non-resident to hold or vote common shares or preference shares with
voting rights (the "Voting Shares"), other than as provided in the *Investment Canada Act* (the "ICA"). The ICA requires a non-Canadian making
an investment which would result in the acquisition of control of a Canadian
business (i.e., the gross value of the assets of which exceed a certain monetary
threshold) or an investment to establish a new Canadian business, to identify,
notify, or file an application for review with the Investment Review Division of
Industry Canada ("IRD").



The notification procedure
involves a brief statement of information about the investment on a prescribed
form which is required to be filed with the IRD by the investor at any time up
to 30 days following implementation of the investment. It is intended that
investments requiring only notification will proceed without government
intervention unless the investment is in a specific type of business activity
related to Canada's cultural heritage and national identity.



If an investment is
reviewable under the ICA, an application for review in the form prescribed is
normally required to be filed with the IRD prior to the investment taking place
and the investment may not be implemented until the review has been completed
and the Minister of Industry ("Minister") (the Minister responsible for
Investment Canada) is satisfied that the investment is likely to be of net
benefit to Canada. The Minister has up to 75 days to make this determination. If
the Minister is not satisfied that the investment is likely to be of net benefit
to Canada, the non-Canadian must not implement the investment or, if the
investment has been implemented, may be required to divest himself of control of
the business that is the subject of the investment.



In 1999, some of the powers,
duties and functions of the Minister were transferred to the Minister of
Canadian Heritage under Parts II to VI of the ICA as they relate to the
prescribed business activities enumerated under paragraph 15(a) of the ICA,
namely those that relate to Canada's "cultural heritage or national identity"
("Cultural Activities"). Cultural Activities include, among other things, the
distribution or sale of books, magazines, film and video recordings and music
recordings. As a result, an application for review must be submitted to the
Cultural Sector Review Division of the Department of Canadian Heritage (the "CSRD") in respect of the acquisition of control of a Canadian business engaged
in a Cultural Activity that exceeds the prescribed lower monetary threshold
applicable to the acquisition of such Canadian businesses.



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The Minister of Canadian
Heritage's review, similar to the Minister's review, is based on the statutory
threshold of net benefit to Canada. CSRD is guided by certain policy statements
regarding investments by non-Canadians in Canadian businesses engaged in certain
Cultural Activities. CSRD's policy statements address certain Cultural
Activities at the production/publication, distribution and/or exhibition levels.



The following investments by
non-Canadians are subject to notification under the ICA:



1. An investment to
  establish a new Canadian business; and



1. An investment to acquire
  control of a Canadian business that is not reviewable pursuant to the Act.



The following investments by
a non-Canadian are subject to review under the ICA:



1. An investment is
  reviewable if there is an acquisition of a Canadian business and the asset
  value of the Canadian business being acquired equals or exceeds the following
  thresholds:



a.For non-World Trade Organization ("WTO") investors, the threshold is CDN$5 million for a direct acquisition and
CDN$50 million for an indirect acquisition; the CDN$5 million threshold will
apply however for an indirect acquisition if the asset value of the Canadian
business being acquired exceeds 50 percent of the asset value of the global
transaction;

b.Except as specified in
paragraph (c) below, a threshold is calculated annually for reviewable direct
acquisitions by or from WTO investors. The threshold for 2006 is
CDN$265 million. Pursuant to Canada's international commitments, indirect
acquisitions by or from WTO investors are not reviewable;

c.The limits set out in paragraph (a)
apply to all investors for acquisitions of a Canadian business that:

i.engages in the production of
uranium and owns an interest in a producing uranium property in Canada;

ii.provides any financial service;

iii.provides any transportation
services; or

iv.is a cultural business.



1. Notwithstanding the
  above, any investment which is usually only notifiable, including the
  establishment of a new Canadian business, and which falls within a specific
  business activity, including the publication and distribution of books,
  magazines, newspapers, film or video recordings, audio or video music
  recordings, or music in print or machine-readable form may be reviewed if an
  Order-in-Council directing a review is made and a notice is sent to the
  Investor within 21 days following the receipt of a certified complete
  notification.



Generally speaking, an
acquisition is direct if it involves the acquisition of control of the Canadian
business or of its direct or indirect Canadian parent and an acquisition is
indirect if it involves the acquisition of control of a non-Canadian direct or
indirect parent of an entity carrying on the Canadian business. No change of
voting control will be deemed to have occurred if less than one-third of the
voting control of a Canadian corporation is acquired by an investor.



A WTO investor, as defined
in the ICA, includes, without limitation, an individual who is a national of a
member country of the WTO or who has the right of permanent residence in
relation that WTO member, a government or government agency of a WTO member, a
limited partnership, trust or joint venture that is neither WTO-investor
controlled or Canadian controlled of which two-thirds of its Board of Directors,
general partners or trustees, as the case may be, are any combination of
Canadians and WTO investors.



The higher thresholds for
WTO investors do not apply if the Canadian business engages in activities in
certain sectors such as uranium, financial services (except insurance),
transportation services or cultural business.



The ICA exempts certain
transactions from the notification and review provisions of ICA, including,
among others, (a) an acquisition of Voting Shares if the acquisition were made
in the ordinary course of that persons' business as a trader or dealer in
securities; (b) an acquisition of control of the company in connection with the
realization of a security interest granted for a loan or other financial
assistance and not for any purpose related to the provisions of the ICA; (c) the
acquisition of voting interests by any person in the ordinary course of a
business carried on by that person that consists of providing, in Canada,
venture capital on terms and conditions not inconsistent with such terms and
conditions as may be fixed by the Minister; and (d) acquisition of control of
the Company by reason of an amalgamation, merger, consolidation or corporate
reorganization, following which the ultimate direct or indirect control in fact
of the Company, through the ownership of voting interests, remains unchanged.



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*Change of Control*



Our articles of
incorporation and by-laws do not contain any specific provision that has the
effect of delaying, deferring or preventing a change of control of our companyor that would operate only with respect to a merger, acquisition or corporate
restructuring involving the company (or any of its subsidiaries).



Our authorized capital
consists of an unlimited number of common shares and an unlimited number of
preferred shares. Although we have not issued any preferred shares to date, the
Board of Directors, may without any further vote by the common shareholders,
issue preferred shares and determine the price, preferences, rights and
restrictions of these shares. The rights of the holders of common shares are
subject to the rights of holders of any preferred shares that the Board of
Directors may issue in the future. That means that we can, for example, issue
preferred shares with higher dividend payments or more favourable rights upon
dissolution, than the common shares. If we issued certain types of preferred
shares in the future, it may also be more difficult for a third-party to acquire
a majority of our outstanding voting shares.



*Disclosure of Ownership*



Our by-laws do not contain provisions regarding
public disclosure of share ownership. Applicable Canadian securities legislation
requires certain public disclosure of the shareholdings of those persons who are
insiders of the Company. Insiders include directors and senior officers as well
as those persons who own common shares that exceed 10 percent of our company's
total issued and outstanding common shares.



C.Material contracts.



In the past two years the Company has not entered
into any material contract (other than contracts entered into in the ordinary
course of business) except for the following:



Settlement Agreement with the Receiver  See Item 4  Information on the
Company  History and Development of the Company and Exhibit 4.12.
Settlement Agreement by and among the Corporation, the Receiver, Michael
Lobsinger and Quarry Bay Investments Inc.



See also the exhibits to
this annual report.



The Company has also entered into employment agreements with certain executive
officers of the Company. See *Item 6 - Directors - Senior Management and
Employees*.



D.Exchange controls.



The Company is aware of no
governmental laws, decrees regulations or other legislation, including foreign
exchange controls, in Canada which may affect the export or import of capital or
that may affect the remittance of dividends, interest or other payments to
non-resident holders of the Company's securities. Any such remittances to United
States residents, however, are subject to a withholding tax pursuant to *The
Canada - U.S. Income Tax Convention* (1980), as amended.



Except as provided in the
ICA, the Company knows of no limitations under the laws of Canada, the Province
of Alberta, or in the charter or any other constituent documents of the Company
imposed on the right of foreigners to hold or vote the shares of the Company.
See *Item 10 - Additional Information Memorandum and Articles of Association
- Limitations on Rights to Own Securities*.



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E.Taxation.



Material Canadian Income Tax Consequences



Generally, cash dividends
paid by Canadian corporations to non-resident shareholders are subject to a
withholding tax of 25 percent. However, the *Canada - U.S. Income Tax
Convention* (1980), as amended ("the Convention"), provides for a 15 percent
withholding tax on dividends paid to all individuals and corporate residents of
the United States qualifying for treaty benefits. Dividends paid to any
non-resident company that beneficially owns at least 10 percent of the voting
stock of the payer company are subject to withholding tax at 5 percent.



A non-resident shareholder
who holds shares of the Company as capital property will not be subject to tax
on capital gains realized on the disposition of such shares unless such shares
are "taxable Canadian property" within the meaning of the *Income Tax Act*
(Canada) and no relief is afforded under any applicable tax treaty. The shares
of the Company would be taxable Canadian property of a non-resident shareholder
if the non-resident shareholder used the shares in carrying on a business in
Canada. The shares of the Company would also be taxable Canadian property of a
non-resident shareholder if at any time during the five year period immediately
preceding the disposition, not less than 25 percent of the issued shares of any
class of the Company belonged to the particular shareholder or persons with whom
the shareholder did not deal at arms' length.



MaterialUnited States Federal Income Tax
Consequences



The following is a general
discussion of certain possible United States ("U.S.") federal income tax
consequences, under current law, generally applicable to a U.S. Holder (as
hereinafter defined) of common shares in the Company.  This discussion is of a
general nature only and does not take into account the
particular facts and circumstances, with respect to U.S. federal income tax
issues, of any particular U.S. Holder.In addition, this discussion does
not cover any state, local or foreign tax consequences.



The following discussion is
based upon the sections of the Internal Revenue Code of 1986, as amended
("Code"), Treasury Regulations, published Internal Revenue Service ("IRS")
rulings, published administrative positions of the IRS and court decisions that
are currently applicable, any or all of which could be materially and adversely
changed, possibly on a retroactive basis, at any time and which are subject to
differing interpretations.  This discussion does not consider the potential
effects, both adverse and beneficial, of any proposed legislation which, if
enacted, could be applied, possibly on a retroactive basis, at any time.



This discussion is for
general information only and it is not intended to be, nor should it be
construed to be, legal or tax advice to any U.S. Holder or prospective U.S.
Holder of common shares issued by the Company, and no opinion or representation
with respect to the U.S. federal income tax consequences to any such U.S. Holder
or prospective U.S. Holder is made.  Accordingly, U.S. Holders and prospective
U.S. Holders of common shares issued by the Company should consult their own
financial advisor, legal counsel or accountant regarding the U.S. federal,
state, local and foreign tax consequences of purchasing, owning and disposing of
common shares issued by the Company.



U.S. Holders.



As used herein, a
"U.S.
Holder" means a holder of common shares issued by the Company who is (i) a
citizen or individual resident of the U.S., (ii) a corporation created or
organized in or under the laws of the U.S. or of any political subdivision
thereof, (iii) an estate whose income is taxable in the U.S. irrespective of
source or (iv) a trust subject to the primary supervision of a court within the
U.S. and control of a U.S. fiduciary as described Section 7701(a)(30) of the
Code.  If a partnership or other "pass-through" entity treated as a partnership
for U.S. federal income tax purposes holds common shares issued by the Company,
the U.S. federal income tax treatment of the partners or owners of such
partnership or other pass-through entity generally will depend on the status of
such partners or owners and the activities of such partnership or pass-through
entity.



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Persons Not Covered.



This summary does not address the U.S. federal
income tax consequences to persons (including persons who are U.S. Holders)
subject to special provisions of U.S. federal income tax law, including but not
limited to (i) persons who are tax-exempt organizations, qualified retirement
plans, individual retirement accounts and other tax-deferred accounts, financial
institutions, insurance companies, real estate investment trusts, regulated
investment companies, or brokers, dealers or traders in securities, (ii) persons
who have a "functional currency" other than the U.S. dollar, (iii) persons
subject to the alternative minimum tax, (iv) persons who own their common shares
as part of a straddle, hedging, conversion transaction, constructive sale or
other arrangement involving more than one position, (v) persons who acquired
their common shares through the exercise of employee stock options or otherwise
as compensation for services, (vi) persons that own an interest in an entity
that owns common shares, (vii) persons who own, exercise or dispose of any
options, warrants or other rights to acquire common shares, (viii) persons who
are partners or owners of partnerships or other pass-through entities such as
corporations subject to Subchapter S of the Code or (ix) persons who own their
common shares other than as a capital asset within the meaning of Section 1221
of the Code.



Distributions Made by the
Company to U.S. Holders.



General Rules. 
U.S. Holders receiving distributions (including constructive distributions) with
respect to common shares issued by the Company are required to include in gross
income as a dividend for U.S. federal income tax purposes the gross amount of
such distributions (without reduction for any Canadian income tax withheld from
such distributions), equal to the U.S. dollar value of such distributions on the
date of receipt (based on the exchange rate on such date), to the extent that
the Company has current or accumulated earnings and profits.  To the extent
that distributions from the Company exceed its current and accumulated earnings
and profits, such distributions will be treated first as a return of capital, to
the extent of the U.S. Holder's adjusted basis in the common shares, and
thereafter as gain from the sale or exchange of the common shares.  (See
more detailed discussion at "Disposition of Common Shares" below). 
Any Canadian tax withheld from a distribution by the Company may be credited,
subject to certain limitations, against the U.S. Holder's U.S. federal income
tax liability or, alternatively, may be deducted in computing the U.S. Holder's
U.S. federal taxable income by those who itemize deductions.  (See more
detailed discussion at "Foreign Tax Credit" below).



Currency Gain or Loss. 
In the case of foreign currency received as a distribution that is not converted
by the recipient into U.S. dollars on the date of receipt, a U.S. Holder will
have a tax basis in the foreign currency equal to its U.S. dollar value on the
date of receipt.  Generally any gain or loss recognized upon a subsequent sale
or other disposition of the foreign currency, including the exchange for U.S.
dollars, will be ordinary income or loss.



Dividend may be
Eligible for Reduced Tax Rate. 
For taxable years beginning after December 31, 2002 and before January 1, 20011,
dividends received by U.S. Holders that are individuals, estates or trusts from
"qualified foreign corporations," as defined in Section 1(h)(11) of the Code,
generally are taxed at the same preferential tax rates applicable to long-term
capital gains.  Although not free from doubt, it appears that the Company would
be a "qualified foreign corporation," as defined in Section 1(h)(11) of the Code
as a result of the U.S.-Canada income tax treaty if, however, the Company is not
a Passive Foreign Investment Company ("PFIC").  The Company has not determined
whether it meets the definition of a PFIC.  A corporation that is properly
described as a PFIC, along with other foreign corporations given special status
under the Code, for its taxable year during which it pays a dividend, or for its
immediately preceding taxable year, will not be treated as a "qualifying foreign
corporation" and dividends received by U.S. Holders that are individuals,
estates or trusts generally will be subject to U.S. federal income tax at
ordinary income tax rates (and not at the preferential tax rates applicable to
long-term capital gains).



Dividends not Eligible
for Dividends Received Deduction.
 Dividends paid by the Company generally will not be eligible for the "dividends
received deduction" allowed to corporate shareholders receiving dividends from
certain U.S. corporations.  Under certain circumstances, a U.S. Holder that is a
corporation and that owns shares representing at least 10% of the total voting
power and the total value of shares issued by the Company may be entitled to a
70% deduction of the "U.S. source" portion of dividends received from the
Company (unless the Company qualifies as a "PFIC" as defined below).  The
availability of the dividends received deduction is subject to several complex
limitations that are beyond the scope of this discussion, and U.S. Holders of
common shares issued by the Company should consult their own financial advisor,
legal counsel or accountant regarding the dividends received deduction.



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Dividend Paid to
Shareholder who Made QEF Election may be Exempt from Tax. 
Generally, shareholders are not subject to additional income taxation on
distributions made by a PFIC to the extent of the shareholder's basis in the
corporation's common shares if a Qualified Electing Fund ("QEF") election is in
effect.  (Please see the "QEF Election" discussion below.)  A
shareholder's basis in this situation is usually equal to the cost of purchasing
the common shares plus the amount of the Company's income that was reported on
the shareholder's return pursuant to the QEF election less any prior
distributions made by the corporation to the shareholder.  Again, these rules
are subject to several exceptions that are beyond the scope of this discussion. 
U.S. Holders of common shares issued by the Company should consult their own
financial advisor, legal counsel or accountant regarding whether dividends paid
by the Company to them will be exempt from federal income tax if a QEF election
is made.



Disposition of Common
Shares.



General Rule. 
A U.S. Holder will recognize gain or loss upon the sale or other taxable
disposition of common shares issued by the Company equal to the difference, if
any, between (i) the amount of cash plus the fair market value of any property
received, and (ii) the shareholder's tax basis in the common shares.  This gain
or loss will be long-term capital gain or loss if the common shares are held for
more than one year.



Reduced Tax Rate. 
Preferential tax rates apply to long-term capital gains of U.S. Holders that are
individuals, estates or trusts.  There are currently no preferential tax rates
for long-term capital gains for a U.S. Holder that is a corporation.  Deductions
for net capital losses are subject to significant limitations.  For U.S. Holders
that are not corporations, any unused portion of such net capital loss may be
carried over to be used in later tax years until such net capital loss is
thereby exhausted.  For U.S. Holders that are corporations, an unused net
capital loss may be carried back three years and carried forward five years from
the loss year to be offset against capital gains until such net capital loss is
thereby exhausted.  Sales of PFIC stock are not eligible for the reduced
long-term capital gains rates that are usually applicable to sales of stock
unless the shareholder made a QEF election regarding such common shares.



The Company may be a
Passive Foreign Investment Company.



General Discussion. 
The Company has not determined whether it meets the definition of PFIC, within
the meaning of Sections 1291 through 1298 of the Code for the current tax year
and any prior tax years.  The Company may or may not qualify as a PFIC in
subsequent years due to changes in its assets and business operations.  A U.S.
Holder who holds stock in a foreign corporation during any year in which such
corporation qualifies as a PFIC is subject to numerous special U.S. federal
income taxation rules and may elect to be taxed under two alternative tax
regimes.  The following is a discussion of these three sets of special rules
applied to U.S. Holders of common shares issued by the Company.  In addition,
special rules apply if a foreign corporation qualifies as both a PFIC and a
"controlled foreign corporation" (as defined below) and a U.S. Holder owns,
actually or constructively, 10 % or more of the total combined voting power of
all classes of stock entitled to vote of such foreign corporation (See more
detailed discussion at "Controlled Foreign Corporation" below).



Definition of PFIC. 
Section 1297 of the Code generally defines a PFIC as a corporation that is not
formed in the U.S. and, for any taxable year, either (a) 75% or more of its
gross income is "passive income" or (b) the average percentage, by fair market
value of its assets that produce or are held for the production of "passive
income" is 50% or more.  "Passive income" includes, for example, dividends,
interest, certain rents and royalties, certain gains from the sale of stock and
securities, and certain gains from commodities transactions.  For purposes of
the PFIC income test and the assets test, if a foreign corporation owns
(directly or indirectly) at least 25% by value of the stock of another
corporation, such foreign corporation shall be treated as if it (a) held a
proportionate share of the assets of such other corporation, and (b) received
directly its proportionate share of the income of such other corporation.  Also,
for purposes of such PFIC tests, passive income does not include any interest,
dividends, rents or royalties that are received or accrued from a "related"
person to the extent such amount is properly allocable to the income of such
related person which is not passive income.  For these purposes, a person is
related with respect to a foreign corporation if such person "controls" the
foreign corporation or is controlled by the foreign corporation or by the same
persons that control the foreign corporation.  For these purposes, "control"
means ownership, directly or indirectly, of stock possessing more than 50% of
the total voting power of all classes of stock entitled to vote or of the total
value of stock of a corporation



Generally Applicable
PFIC Rules.  If a U.S. Holder does
not make a timely election to be taxed in conformity with the Mark-to-Market
rules (as described below) or the QEF rules (as described below) during a year
in which it holds (or is deemed to have held) common shares issued by the
Company while it is a PFIC (a "Non-Electing U.S. Holder"), then special taxation
rules under Section 1291 of the Code will apply to (i) gains realized on the
disposition (or deemed to be realized by reasons of a pledge) of his common
shares and (ii) certain "excess distributions" (generally, distributions
received in the current taxable year that are in excess of 125% of the average
distributions received during the three preceding years or, if shorter, the U.S.
Holder's holding period) by the Company.



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A Non-Electing U.S. Holder
generally would be required to pro rate all gains realized on the disposition of
his common shares and all excess distributions on his common shares over the
entire holding period for the common shares.  All gains or excess distributions
allocated to prior years of the U.S. Holder (other than years prior to the
Company's first taxable year during such U.S. Holder's holding period and
beginning after January 1, 1987 for which the Company was a PFIC) would
generally be taxed at the highest tax rate for each such prior year applicable
to ordinary income, and such Non-Electing U.S. Holder also would be liable for
interest on the foregoing tax liability for each such prior year calculated as
if such liability had been due with respect to each such prior year.  A
Non-Electing U.S. Holder that is not a corporation must treat this interest
charge as "personal interest" which, as discussed above, is wholly nondeductible.  The balance of the gain or the excess distribution will be
treated as ordinary income in the year of the disposition or distribution, and
no interest charge will be incurred with respect to such balance.



If the Company is a PFIC for
any taxable year during which a Non-Electing U.S. Holder holds common shares
issued by the Company, then it will continue to be treated as a PFIC with
respect to such common shares, even if it ceases meeting the definition of a
PFIC.  A Non-Electing U.S. Holder may terminate this deemed PFIC status by
electing to recognize gain (which will be taxed under the rules discussed above
for Non-Electing U.S. Holders) as if such common shares had been sold on the
last day of the last taxable year for which it was a PFIC.



Mark-to-Market
Election.  Effective for tax years
of U.S. Holders beginning after December 31, 1997, U.S. Holders who hold,
actually or constructively, marketable stock (as specifically defined in the
Treasury Regulations) of a foreign corporation that qualifies as a PFIC may
annually elect to mark such stock to the market (a "mark-to-market election"). 
If such an election is made, such U.S. Holder will generally not be subject to
the special taxation rules of Section 1291 discussed above.  However, if the
mark-to-market election is made by a Non-Electing U.S. Holder after the
beginning of the holding period for the PFIC stock, then the Section 1291 rules
will apply to certain dispositions of, distributions on and other amounts
taxable with respect to the Company's common shares.  A U.S. Holder who makes
the mark-to market election will include in income for the taxable year for
which the election was made an amount equal to the excess, if any, of the fair
market value of the Company's common shares as of the close of such tax year
over such U.S. Holder's adjusted basis in such common shares.  In addition, the
U.S. Holder is allowed a deduction for the lesser of (i) the excess, if any, of
such U.S. Holder's adjusted tax basis in the common shares over the fair market
value of such shares as of the close of the tax year, or (ii) the excess, if
any, of (A) the mark-to-market gains for the Company's common shares included by
such U.S. Holder for prior tax years, including any amount which would have been
included for any prior tax year but for the Section 1291 interest on tax
deferral rules discussed above with respect to Non-Electing U.S. Holders, over
(B) the mark-to-market losses for common shares that were allowed as deductions
for prior tax years.  A U.S. Holder's adjusted tax basis in his common shares
will be adjusted to reflect the amount included in or deducted from income as a
result of a mark-to-market election.  A mark-to-market election applies to the
taxable year in which the election is made and to each subsequent taxable year,
unless the common shares cease to be marketable, as specifically defined, or the IRS consents to revocation of the election.



QEF Election. 
In general, a U.S. Holder who makes a timely QEF election (an "Electing U.S.
Holder") regarding his common shares issued by the Company will be subject,
under Section 1293 of the Code, to current U.S. federal income tax for any
taxable year in which the Company qualifies as a PFIC on his pro rata share of
the Company's (i) "net capital gain" (the excess of net long-term capital gain
over net short-term capital loss), which will be taxed as long-term capital gain
to the Electing U.S. Holder and (ii) "ordinary earnings" (the excess of earnings
and profits over net capital gain), which will be taxed as ordinary income to
the Electing U.S. Holder, in each case, for the shareholder's taxable year in
which (or with which) the Company's taxable year ends, regardless of whether
such amounts are actually distributed.



The effective QEF election
also allows the Electing U.S. Holder to (i) generally treat any gain realized on
the disposition of his common shares (or deemed to be realized on the pledge of
his common shares) as capital gain; (ii) treat his share of the Company's net
capital gain, if any, as long-term capital gain instead of ordinary income; and
(iii) either avoid interest charges resulting from PFIC status altogether, or
make an annual election, subject to certain limitations, to defer payment of
current taxes on his share of the Company's annual realized net capital gain and
ordinary earnings subject, however, to an interest charge.  If the Electing U.S.
Holder is not a corporation, such an interest charge would be treated as
"personal interest" that is not deductible.



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The procedure a U.S. Holder
must comply with in making an effective QEF election, and the U.S. federal
income tax consequences of the QEF election, will depend on whether the year of
the election is the first year in the U.S. Holder's holding period in which the
Company is a PFIC.  If the U.S. Holder makes a QEF election in such first year,
i.e., a timely QEF election, then the U.S. Holder may make the QEF
election by simply filing the appropriate QEF election documents at the time the
U.S. Holder files his tax return for such first year.  However, if the Company
qualified as a PFIC in a prior year, then in addition to filing the QEF election
documents, the U.S. Holder must elect to recognize (i) under the rules of
Section 1291 of the Code (discussed herein), any gain that he would otherwise
recognize if the U.S. Holder sold his stock on the qualification date or (ii) if
the Company is a controlled foreign corporation, the U.S. Holder's pro rata
share of the Company's post-1986 earnings and profits as of the qualification
date.  The qualification date is the first day of the Company's first tax year
in which the Company qualified as a QEF with respect to such U.S. Holder.  The
elections to recognize such gain or earnings and profits can only be made if
such U.S. Holder's holding period for the common shares includes the
qualification date.  By electing to recognize such gain or earnings and profits,
the U.S. Holder will be deemed to have made a timely QEF election.  A U.S.
Holder who made elections to recognize gain or earnings and profits after May 1,
1992 and before January 27, 1997 may, under certain circumstances, elect to
change such U.S. Holder's qualification date to the first day of the first QEF
year.  U.S. Holders are urged to consult a tax advisor regarding the
availability of and procedure for electing to recognize gain or earnings and
profits under the foregoing rules.  In addition to the above rules, under
very limited circumstances, a U.S. Holder may make a retroactive QEF election if
such U.S. Holder failed to file the QEF election documents in a timely manner.



A QEF election, once made
with respect to the Company, applies to the tax year for which it was made and
to all subsequent tax years, unless the election is invalidated or terminated,
or the IRS consents to revocation of the election.  If a QEF election is made by
a U.S. Holder and the Company ceases to qualify as a PFIC in a subsequent tax
year, the QEF election will remain in effect, although not applicable, during
those tax years in which the Company does not qualify as a PFIC.  Therefore, if
the Company again qualifies as a PFIC in a subsequent tax year, the QEF election
will be effective and the U.S. Holder will be subject to the rules described
above for Electing U.S. Holders in such tax year and any subsequent tax years in
which the Company qualifies as a PFIC.  In addition, the QEF election remains in
effect, although not applicable, with respect to an Electing U.S. Holder even
after such U.S. Holder disposes of all of his or its direct and indirect
interest in the Company's common shares.  Therefore, if such U.S. Holder
reacquires an interest in the Company, that U.S. Holder will be subject to the
rules described above for Electing U.S. Holders for each tax year in which the
Company qualifies as a PFIC.



Generally, shareholders do
not make a QEF election unless they have sufficient information to determine
their proportionate share of a corporation's net capital gain and ordinary
earnings.  The Company has not calculated these amounts for any shareholder, and
do not anticipate making these calculations in the foreseeable future.  Therefore, U.S. Holders of the Company's common shares should consult their own
financial advisor, legal counsel or accountant regarding the QEF election before
making this election.



Other PFIC Rules. 
Under Section 1291(f) of the Code, the IRS has issued Proposed Treasury
Regulations that, subject to certain exceptions, would treat as taxable certain
transfers of PFIC stock by Non-Electing U.S. Holders that are generally not
otherwise taxed, such as gifts, exchanges pursuant to corporate reorganizations,
and transfers at death.  Generally, in such cases the basis of common shares in
the hands of the transferee and the basis of any property received in the
exchange for those common shares would be increased by the amount of gain
recognized.  However, the specific U.S. federal income tax consequences to the
U.S. Holder and the transferee may vary based on the manner in which the common
shares are transferred.



Certain special, generally
adverse, rules will apply with respect to common shares issued by the Company
while it is a PFIC whether or not it is treated as a QEF.  For example under
Section 1298(b)(6) of the Code, a U.S. Holder who uses PFIC stock as security
for a loan (including a margin loan) will, except as may be provided in
regulations, be treated as having made a taxable disposition of such shares.



The PFIC rules are very
complicated, and U.S. Holders should consult their own financial advisor, legal
counsel or accountant regarding the PFIC rules, including the advisability of
and procedure for making a QEF election or a mark-to-market election, and how
these rules may impact their U.S. federal income tax situation.



82

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Foreign Tax Credit.



A U.S. Holder who pays (or
has withheld from distributions) Canadian or other foreign income tax with
respect to the ownership of common shares issued by the Company may be entitled,
at the option of the U.S. Holder, to either receive a deduction or a tax credit
for U.S. federal income tax purposes with respect to such foreign tax paid or
withheld.  There are significant and complex limitations that apply to the
foreign tax credit, among which is the general limitation that the credit cannot
exceed the proportionate share of the U.S. Holder's U.S. income tax liability
that the U.S. Holder's "foreign source" income bears to his or its worldwide
taxable income.  In applying this limitation, the various items of income and
deduction must be classified as either "foreign source" or "U.S. source." 
Complex rules govern this classification process.



In addition, U.S. Holders
that are corporations and that own 10% or more of the Company's voting stock may
be entitled to an "indirect" foreign tax credit under Section 902 of the Code
with respect to the payment of dividends by the Company under certain
circumstances and subject to complex rules and limitations.The availability
of the foreign tax credit and the application of the limitations with respect to
the foreign tax credit are fact specific, and each U.S. Holder of common shares
issued by the Company should consult their own financial advisor, legal counsel
or accountant regarding the foreign tax credit rules.



Information Reporting;
Backup Withholding.



Certain information
reporting and backup withholding rules may apply with respect to certain
payments related to common shares issued by the Company.  In particular, a payor
or middleman within the U.S., or in certain cases outside the U.S., will be
required to withhold at a current rate of 28% (which rate is scheduled for
periodic adjustment) of any payments to a U.S. Holder regarding dividends paid
by the Company, or proceeds from the sale of, such common shares within the
U.S., if a U.S. Holder fails to furnish its correct taxpayer identification
number (generally on Form W-9) or otherwise fails to comply with, or establish
an exemption from, the backup withholding tax requirements.  Any amounts
withheld under the U.S. backup withholding tax rules will be allowed as a refund
or a credit against the U.S. Holder's U.S. federal income tax liability,
provided the required information is furnished to the IRS.  U.S. Holders
should consult their own financial advisor, legal counsel or accountant
regarding the information reporting and backup withholding rules applicable to
the Company's common shares.



Other Considerations for U.S. Holders.



In the following circumstances, the above
sections of this discussion may not describe the U.S. federal income tax
consequences to U.S. Holders resulting from the ownership and disposition of
common shares issued by a foreign corporation.



Controlled Foreign
Corporation.



If more than 50% of the
total voting power or the total value of the Company's outstanding shares is
owned, directly or indirectly, by citizens or residents of the U.S., U.S.
partnerships or corporations, or U.S. estates or trusts (as defined by the Code
Section 7701(a)(30)), each of which own, directly or indirectly, 10% or more of
the total voting power of the Company's outstanding shares (each a "10%
Shareholder"), the Company could be treated as a "Controlled Foreign
Corporation" ("CFC") under Section 957 of the Code.



The classification of the
Company as a CFC would effect many complex results, including that 10%
Shareholders would generally (i) be treated as having received a current
distribution of the Company's "Subpart F income" and (ii) would also be subject
to current U.S. federal income tax on their pro rata share of the Company's
earnings invested in "U.S. property."  The foreign tax credit may reduce the
U.S. federal income tax on these amounts for such 10% Shareholders (See more
detailed discussion at "Foreign Tax Credit" above).  In addition, under Section
1248 of the Code, gain from the sale or other taxable disposition of the
Company's common shares by a U.S. Holder that is or was a 10% Shareholder at any
time during the five-year period ending with the sale is treated as a dividend
to the extent of the Company's earnings and profits attributable to the common
shares sold or exchanged.



83

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If the Company is classified
as both a PFIC and a CFC, it generally will not be treated as a PFIC with
respect to 10% Shareholders.  This rule generally will be effective for taxable
years of 10% Shareholders beginning after 1997 and for its taxable years ending
with or within such taxable years of 10% Shareholders.



The Company has not
determined whether it meets the definition of a CFC, and there can be no
assurance that it will not be considered a CFC for the current or any future
taxable year.



The CFC rules are very
complicated, and U.S. Holders should consult their own financial advisor, legal
counsel or accountant regarding the CFC rules and how these rules may impact
their U.S. federal income tax situation.



F.Dividends and paying
agents.



Not applicable.



G.Statement by
experts.



Not applicable.



H.Documents on
display.



Public documents are
available for inspection at the Company's head offices located at 2100, 840 - 7th Avenue
S.W., Calgary, AB T2P 3G2, and, for certain documents, on the Internet at
www.sedar.com and at www.sec.gov.



The Company is subject to
the information requirements of the *Securities Exchange Act of 1934*, as
amended (the "Exchange Act"), and, to the extent required of Canadian companies,
files periodic reports and other information with the SEC. All such reports and
information may be read and copied at the public reference facilities listed
below. The Company intends to give its shareholders annual reports containing
audited financial statements and a report thereon from its independent chartered
accountants and quarterly reports for the first three quarters of each fiscal
year containing unaudited interim financial information.



Statements made in this
annual report on Form 20-F about the contents of contracts or other documents
are not necessarily complete and we refer shareholders to the copy of such
contracts or other documents filed as exhibits to this annual report.



The Company's SEC filings,
and the exhibits thereto, are available for inspection and copying at the public
reference facilities maintained by the SEC in Judiciary Plaza, Room 1580, 100 F
Street N.W., Washington, D.C., 20549. Copies of these filings may be obtained
from these offices after the payment of prescribed fees. Please call the SEC at
1-800-SEC-0330 for further information on the public reference rooms. These
filings are also available on the SEC's website at www.sec.gov.



The Company will also
provide its shareholders with proxy statements prepared according to Canadian
law. As a Canadian company, the Company is exempt from the Exchange Act rules
about prescribing the furnishing and content of proxy statements to shareholders
and is also exempt from the short-swing profit recovery and disclosure regime of
Section 16 of the Exchange Act.



I.Subsidiary Information.



Not applicable.



Item 11. Quantitative and Qualitative Disclosures About Market
Risk.



(A)          Quantitative information about market risk.



Accounts receivable, cash
equivalents, investment in a significantly influenced company, accounts payable,
accrued liabilities, note payable, capital lease obligations and other deferred
costs constitute financial instruments. The carrying values of these financial
instruments approximate their fair value given the relatively short periods to
maturity. The carrying values for these financial instruments represent their
maximum credit risk. The note receivable constitutes a financial instrument with
a fair value that is not determinable due, in part, to the unrecognized
contingent portion of the note (note 4). The investment in a 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.



84

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The Company maintains
substantially all cash and cash equivalents with major financial institutions.
Deposits held with banks may exceed the amounts of insurance provided on such
deposits. Credit risk exposure includes accounts receivable with customers
primarily located in North America, China, Korea, and Western Europe. The
Company performs ongoing credit evaluations of its customers' financial
condition and, generally, require no collateral from customers. The Company is
exposed to the risks arising from fluctuations in foreign exchange rates, and
the volatility of those rates. The Company does not use derivative instruments
to reduce its exposure to foreign currency exchange risk.



(B)           Qualitative information about market risk



*Interest Rate Risk*



The Company does not
maintain any market risk sensitive instruments for trading purposes or
instruments entered into for purposes other than trading purposes, other than
maintaining a short term investment portfolio consisting mainly of term deposits
purchased with an average maturity of less than three months. These securities
are subject to interest rate risk and will fall in value if market interest
rates increase. If market interest rates were to increase immediately and
uniformly by 10 percent of their levels at December 31, 2006, the fair value of
the portfolio would decline by an immaterial amount. The Company generally has
the ability to hold its fixed income investments until maturity and therefore it
would not expect its operating results or cash flows to be affected to any
significant degree by the effect of a sudden change in market interest rates on
its investment portfolio.



*Foreign Exchange Rate Risk*



The foreign operations of
the Company are translated into U.S. dollars for financial statement
presentation. Consequently, movements in exchange rates may have significant
impact on financial results.



Substantially all of the
Company's product revenues are denominated in U.S. dollars while expenses are
denominated in Canadian dollars, Hong Kong dollars, U.S. dollars, 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.



Item 12. Description of Securities Other than Equity
Securities.



Not applicable.



PART II



Item 13. Defaults, Dividend Arrearages and Delinquencies.



None.



Item 14. Material Modifications to the Rights of Security
Holders and Use of Proceeds.



Not applicable



Item 15. Controls and Procedures.



As of December 31, 2006, we
carried out an evaluation, under the supervision and with the participation of
our principal executive officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based on this
evaluation, our principal executive officer and principal financial officer have
concluded that as of December 31, 2006, our disclosure controls and procedures
are effective to ensure that information required to be disclosed in our
periodic reports filed or submitted under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified by the
SEC's rules and forms, and accumulated and communicated to the Company's
management, including the principal executive officer and principal financial
officer, to allow timely decisions regarding required disclosure.



85

---





The Company's management is
responsible for establishing and maintaining adequate internal control over
financial reporting to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. As
disclosed in the company's annual report on Form 20-F for the financial year
ended December 31, 2004, the Company identified a "material weakness" in its
internal controls over financial reporting, as defined in Public Company
Accounting Oversight Board ("PCAOB"), Auditing Standard No. 2. As defined by the PCAOB, a material weakness is
"a significant deficiency, or a combination of
significant deficiencies, that results in more than a remote likelihood that a
material misstatement of the annual or interim financial statements will not be
prevented or detected." The material weakness related to a failure to properly
reflect in the notes to the consolidated financial statements the stock based
compensation expense reflecting a variety of vesting periods consistent with the
Company's stock option grants. In 2003, the determination of the stock based
compensation expense was based on amortization periods that did not best reflect
the variety of vesting periods for the associated stock option grants.
Accordingly, the Company restated the 2003 stock compensation expense and
appropriate related balances as disclosed in notes 2 and 16 to the Company's
2004 consolidated financial statements.



During the course of the
period covered by the Form 20-F for the financial year ended December 31, 2005,
management undertook new control measures to remediate the issue discussed
above. These measures included making appropriate changes to the Company's
documented accounting policies and procedures for stock based compensation
accounting and the associated stock option grants and added an additional
Chartered Accountant to the Company's accounting department staff. There were no
other changes in the Company's internal control over financial reporting that
occurred during the year ended December 31, 2005 that have materially affected,
or are reasonably likely to materially affect, the Company's internal control
over financial reporting. Following the implementation of these measures,
management concluded that the material weakness discussed above had been remediated and that the Company's disclosure controls and procedures were
sufficiently well developed to support an assessment that these controls and
procedures were effective.



While the Company concluded that its disclosure controls and procedures controls
were effective, in connection with the Company's implementation of Section 404
of the Sarbanes Oxley Act ("Sox 404"), the Company is in the process of strengthening controls
and remediating identified deficiencies in its controls and procedures. In the
event that deficiencies that have been or might be identified are not remediated
within the required period, once tested, such deficiencies could result in a
conclusion that the Company has a material weakness in internal control. The
Company is required to comply with the management report requirements of Sox 404
by December 31, 2007, and with the auditor attestation requirements of Sox 404
by December 31, 2008.



Item 16. [Reserved]



Item 16A. Audit committee financial expert.



The Board of Directors of the Company has
appointed Mr. H. Donald Hyde to the audit committee. Mr. Hyde is a chartered
accountant and has had his own practice since 1991. Prior to setting up his own
practice, Mr. Hyde was the vice president of finance and administration for an
international oil and gas drilling and service company. The Board of Directors
has determined that Mr. Hyde possesses the necessary attributes for designation
as the Company's audit committee financial expert and has designated Mr. Hyde as
its audit committee financial expert. Management of the Company believes that
Mr. Hyde and the other members of the Audit Committee have the skills,
experience and education that qualify them to carry out their duties as members
of the Audit Committee. Mr. Hyde is independent as defined by the listing
standards of the NASDAQ Market System.



Item 16B. Code of Ethics.



The Company has adopted a
Code of Business Conduct and Ethics that currently applies to its directors,
officers and employees. Copies of the code will be provided to any person free
of charge upon receipt of a written request, sent to our registered office via
mail or fax.



86

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Item 16C. Principal Accountant Fees and Services.



Audit Fees



Deloitte & Touche LLP were
the Company's independent registered chartered accountants for both 2006 and
2005. Audit fees paid were $287,665 for 2006 and $220,934 for 2005. Audit fees
relate to the audit of the year end financial statements, reviews of interim
financial statements, and review of SEC filings.



Audit Related Fees



Audit related fees paid were
$58,427 for 2006 and $41,366 for 2005. Audit related fees paid in 2006 were
related to consultations concerning financial accounting and reporting standards
and the accounting for acquisitions and dispositions carried out by the Company.



Tax Fees



In 2006, we paid Deloitte & Touche LLP $189,903
for tax related services. In 2005, we paid Deloitte & Touche LLP $69,743 for tax
related services.



All
Other Fees



We did not purchase any
other services from Deloitte & Touche LLP in 2006 or 2005.



Our Audit Committee has
adopted a policy and procedures for the approval of audit and non-audit services
rendered by our independent registered chartered accountants, Deloitte & Touche
LLP, other than any de minimus non-audit services allowed by applicable law or
regulation. The policy generally requires the Audit Committee's approval of the
scope of the engagement of our independent registered chartered accountants on
an individual basis. The policy prohibits retention of the independent
registered chartered accountants to perform the prohibited non-audit functions
defined in Section 201 of the Sarbanes-Oxley Act of 2002 or the rules of the
SEC, and also considers whether proposed services are compatible with the
independence of the registered chartered accountants. Our Audit Committee has
approved all of the audit fees, audit-related fees and tax fees from May 2003
onward.



Item 16D. Exemptions from the Listing Standards for Audit
Committees.



Not applicable.



Item 16E.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers.



Not applicable.



PART III



Item 17. Financial Statements.



Not Applicable.



Item 18. Financial Statements.



See attached.



Item 19. Exhibits.



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

****



87

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**SIGNATURES**



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



**ZI CORPORATION**Per:
      /s/*Milos Djokovic*Milos DjokovicPresident and Chief
      Executive OfficerDate:March
      30, 2007Per:
      /s/ *Blair Mullin*Blair MullinChief Financial
      OfficerDate:March
      30, 2007






88

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**ANNUAL REPORT ON FORM 20-F**

**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.                                                                                                                                                                                     



89

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|     |                                                                                                
|---- | -----------------------------------------------------------------------------------------------
|12.2 | Section 302 Certification by Milos Djokovic, Chief Executive Officer dated
    March 30, 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.
|     |                                                                                                
|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.
|    |                                                                       





90

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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 MullinPresident and
    Chief Executive Officer
    Chief Financial OfficerMarch 30, 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 statement for the year ended
December 30, 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, 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 and when. 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 dated March 29, 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
- 2 -
Consolidated Balance Sheets
As at December 31,
    
    
    2006
    
    2005(All amounts in United States of
    America dollars except share amounts)
    
    
    
    Restated  see note 3AssetsCurrent assetsCash and cash equivalents
    
    $
    1,672,847
    $
    11,509,321Restricted cash
    
    
    2,160,495
    
    648,119Accounts receivable, net of allowance of $936,731
    (2005 - $426,697)
    
    
    5,785,954
    
    4,579,966Work-in-progress and inventory
    
    
    
    
    13,897Prepayments and deposits
    
    
    599,963
    
    607,375Total current assets
    
    
    10,219,259
    
    17,358,678Capital assets -
    net (note 5)
    
    
    906,094
    
    1,210,947Intangible assets - net (note 6)
    
    
    3,421,717
    
    3,834,880$
    14,547,070
    $
    22,404,505Liabilities and
    shareholders' equityCurrent
    liabilitiesBank indebtedness (note 7)
    
    $
    1,000,000
    $
    106,650Accounts payable and accrued liabilities (note
    17)
    
    
    4,046,022
    
    4,547,725Deferred revenue
    
    
    4,478,026
    
    4,185,341Deferred tax (note 11)
    
    
    174,400
    
    Current portion of other long-term liabilities
    (note 8)
    
    
    30,467
    
    64,927Total current liabilities
    
    
    9,728,915
    
    8,904,643Notes Payable
    (note 7)
    
    
    
    
    147,678Other long-term liabilities (note
    8)
    
    
    
    
    30,5309,728,915
    
    9,082,851Contingent
    liabilities, commitments and guarantees (notes 13 & 15)Going concern
    (note 2)Shareholders'
    equityShare 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
    
    109,365,824Additional
    paid-in capital
    
    
    3,101,201
    
    2,114,190Accumulated
    deficit
    
    
    (108,575,499)
    
    (97,580,615)Accumulated other comprehensive
    loss
    
    
    (342,632)
    
    (577,745)4,818,155
    
    13,321,654$
    14,547,070
    $
    22,404,505See accompanying
    notes to consolidated financial statements.
[signed]
    [signed]Richard D. Tingle
    Donald HydeChairman of the
    Board
    Director- 3 -
Consolidated Statements of Loss
Years ended December 31,
    
    2006
    
    2005
    
    2004(All amounts in United States of
    America dollars except share amounts)
    
    
    
    
    Restated  see note 3RevenueRoyalty, license and implementation fees
    $
    11,836,217
    $
    10,614,043
    $
    12,898,838Other product revenue
    
    555,523
    
    770,470
    
    504,21312,391,740
    
    11,384,513
    
    13,403,051Cost of salesRoyalty, license and implementation costs
    
    406,463
    
    355,597
    
    362,562Other product costs
    
    22,696
    
    248,689
    
    109,252429,159
    
    604,286
    
    471,814Gross margin
    
    11,962,581
    
    10,780,227
    
    12,931,237Operating
    expensesSelling general
    and administrative
    
    (11,867,117)
    
    (9,861,123)
    
    (9,281,365)Litigation and
    legal (note 13)
    
    (3,363,188)
    
    (1,673,486)
    
    (833,197)Product research
    and development
    
    (4,367,427)
    
    (4,243,172)
    
    (2,350,141)Depreciation and
    amortization (note 6)
    
    (1,669,847)
    
    (1,134,554)
    
    (926,886)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
    
    (9,304,998)
    
    (4,966,492)
    
    (2,460,352)Interest on capital lease obligation
    
    (795)
    
    (3,924)
    
    (25,558)Other interest expense
    
    (17,211)
    
    (2,368)
    
    (30,839)Interest income and other income
    
    236,594
    
    366,796
    
    128,550Loss before undernoted
    
    (9,086,410)
    
    (4,605,988)
    
    (2,388,199)Equity interest in loss of significantly
    influenced company (note 10)
    
    (893,973)
    
    
    
    Impairment of note receivable (note 12)
    
    (129,417)
    
    
    
    Minority interest (note 3)
    
    
    
    (23,920)
    
    Income taxes (note 11)
    
    (885,084)
    
    (687,515)
    
    (336,161)Net loss
    $
    (10,994,884)
    $
    (5,317,423)
    $
    (2,724,360)Basic and diluted loss per share
    (note 9 and 17)
    $
    (0.24)
    $
    (0.12)
    $
    (0.07)Weighted average common shares 
    basic and diluted
    
    46,502,728
    
    46,152,711
    
    41,373,309Common shares outstanding, end of
    year
    
    46,688,624
    
    46,272,568
    
    45,225,190See accompanying
    notes to consolidated financial statements.
- 4 -
Consolidated Statements of Shareholders' Equity
Accumulatedother
    
    TotalCommon shares  issued
    
    Additional
    
    Accumulated
    
    comprehensive
    
    comprehensiveshares
    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
    
    2,851,188Issued 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
    
    275,834Balance  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
    
    235,113Balance  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)
    
    
    
    
    Restated  see note 3Net cash flow
    from (used in) operating activities:Net loss
    $
    (10,994,884)
    $
    (5,317,423)
    $
    (2,724,360)Items not affecting cash:Depreciation and amortization
    
    1,709,525
    
    1,162,118
    
    926,886Equity in net loss of significant influenced
    company (note 10)
    
    893,973
    
    
    
    Impairment of note receivable
    
    129,417
    
    250,000
    
    2,000,000Stock compensation expense - employees
    
    1,544,755
    
    
    
    685,767Stock compensation expense  non-employees
    
    
    
    
    
    685,631Loss on dispositions of capital assets
    
    24,212
    
    8,354
    
    9,899Decrease (increase) in non-cash working capital:Accounts receivable
    
    (1,923,617)
    
    1,660,575
    
    (1,561,047)Prepayments and deposits
    
    (41,350)
    
    (39,906)
    
    (15,227)Accounts payable and accrued liabilities
    
    361,640
    
    110,063
    
    (681,866)Deferred revenue
    
    754,775
    
    1,019,146
    
    1,604,532Deferred tax
    
    174,400
    
    
    
    Cash flow from (used in) operating activities
    
    (7,367,154)
    
    (1,147,073)
    
    930,215Cash flow from (used in)
    financing activities:Proceeds from issuance of common shares, net of
    issuance costs
    
    
    
    2,342,054
    
    12,209,030Settlement of note payable
    
    
    
    
    
    (1,000,000)Bank indebtedness (note 7)
    
    893,350
    
    106,650
    
    Payment of capital lease obligations
    
    (7,545)
    
    (16,141)
    
    Cash flow from financing activities
    
    885,805
    
    2,432,563
    
    11,209,030Cash flow from (used in)
    investing activities:Note receivable
    
    
    
    (250,000)
    
    Purchase of capital assets
    
    (304,457)
    
    (256,579)
    
    (178,258)Software development costs
    
    (1,407,204)
    
    (930,264)
    
    (1,661,974)Other deferred costs
    
    (57,445)
    
    (52,732)
    
    (52,397)Deconsolidation of subsidiary
    
    (181,199)
    
    
    
    Acquisition of subsidiaries
    
    
    
    (434,546)
    
    Changes in restricted cash
    
    (1,512,376)
    
    114,927
    
    (550,281)Cash flow used in investing activities
    
    (3,462,681)
    
    (1,809,194)
    
    (2,442,910)Effect of foreign exchange rate
    changes on cash and cash equivalents
    
    107,556
    
    (93,264)
    
    275,834Net cash (outflow) inflow
    
    (9,836,474)
    
    (616,968)
    
    9,972,169Cash and cash equivalents,
    beginning of year
    
    11,509,321
    
    12,126,289
    
    2,154,120Cash and cash equivalents, end of
    year
    $
    1,672,847
    $
    11,509,321
    $
    12,126,289Non-cash financing activityEquipment acquired under capital lease
    $
    
    $
    
    $
    29,118Components of
    cash and cash equivalentsCash
    $
    1,294,185
    $
    4,120,256
    $
    5,104,654Cash equivalents
    $
    378,662
    $
    7,389,065
    $
    7,021,635Total cash and cash equivalents
    $
    1,672,847
    $
    11,509,321
    $
    12,126,289Supplemental cash
    flow informationCash paid for interest
    $
    18,006
    $
    6,292
    $
    56,397Cash paid for income taxes
    $
    772,260
    $
    687,515
    $
    See accompanying
    notes to consolidated financial statements.
- 6 -
Notes to the
Consolidated Financial Statements
For 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.

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 $7,367,154. 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.

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 Statements
For 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") 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) 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. Unrecorded
losses would be first offset against the Company's proportionate share of income
from the equity investment upon the investee's return to profitability.

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 Statements
For 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 Statements
For 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 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.

Share issue costs

The Company reduced the value of consideration assigned to
shares issued by direct costs, net of applicable income tax recoveries, of
issuing the shares.

Loss per share

- 10 -

---

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



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 Statements
For 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 Statements
For 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

- 13 -

---

Notes to the
Consolidated Financial Statements
For 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

- 14 -

---

Notes to the
Consolidated Financial Statements
For 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.

5.     Capital Assets

|                                                                                                                                                                                                                                                                        |   |            |   | 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                                                                                                                                                                                                                                           | $ | 3,654,212  | $ | 2,618,484    | $ | 1,035,728
|Leasehold improvements                                                                                                                                                                                                                                                  |   | 636,804    |   | 461,585      |   | 175,219  
|                                                                                                                                                                                                                                                                        | $ | 4,291,016  | $ | 3,080,069    | $ | 1,210,947
|                                                                                                                                                                                                                                                                        |   |            |   |              |   |          
|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). The decline in capital assets is due to the
    deconsolidation of Archer.
|                                                                                                                                                                                                                                                                        |   |            |   |              |   |          
|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  |   | 7,688,289    |   | 1,893,614
|Ministry registration and assistant
    programs                                                                                                                                                                                                                        |   | 135,742    |   |             |   | 135,742  
|Curriculum                                                                                                                                                                                                                                                              |   | 134,590    |   |             |   | 134,590  
|Contracts relationship                                                                                                                                                                                                                                                  |   | 338,498    |   |             |   | 338,498  
|                                                                                                                                                                                                                                                                        | $ | 12,016,829 | $ | 8,181,949    | $ | 3,834,880

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.

- 15 -

---

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



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.

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:

- 16 -

---

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



|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.

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 

- 17 -

---

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



|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       | Shares       
|                                                                                                    | under options | average        | under options
|                                                                                                    | 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 intrinsicvalue 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:

|                            |               | Weighted          
|--------------------------- | ------------- | ------------------
|                            | Shares        | average fair-value
|                            | under options | 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 Statements
For 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
|------------------------ | -------------------------------------------- | ----------------------------------
|                         | Number outstanding                           | Weighted
    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

The Company holds a 42.2 percent interest in Archer received
through a series of transactions as discussed in note 4. 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. Unrecorded losses would be first offset against the
Company's proportionate share of income from the equity investment upon the investee's return to profitability.

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
|Canadian Operations                                                                                                                       | $ | (8,158,275)  | $ | (9,061,339) | $                     | (5,562,707)
|International Operations                                                                                                                  |   | (1,951,525)  |   | 4,431,431   |                       | 3,174,508  
|                                                                                                                                          | $ | (10,109,800) | $ | (4,629,908) | $                     | (2,388,199)
|                                                                                                                                          |   |              |   |             |                       |            
|The Components of income tax expense are as follows:                                                                                     
|                                                                                                                                          |   | 2006         |   | 2005        |                       | 2004       
|                                                                                                                                          |   |              |   |             | Restated  see note 3
|Canadian Operations                                                                                                                       | $ | -            | $ | -           | $                     |           
|International Operations                                                                                                                  | $ | 885,084      | $ | 687,515     | $                     | 336,161    
|                                                                                                                                          |   |              |   |             |                       |            
|The provision for
    income taxes reflects an effective tax rate that differs from the corporate
    tax rate for the following reasons:
|                                                                                                                                          |   |              |   |             |                       |            

- 19 -

---

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



|                                                                                        |   | 2006         |   | 2005         |                       | 2004        
|--------------------------------------------------------------------------------------- | - | ------------ | - | ------------ | --------------------- | ------------
|                                                                                        |   |              |   |              | Restated  see note 3
|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 | $ | (3,684,178)  | $ | (1,548,533)  | $                     | (874,081)   
|Enacted tax rate adjustment differences                                                 |   | 104,426      |   |             |                       | 151,862     
|Differences in foreign statutory tax rates                                              |   | 373,247      |   | 433,916      |                       | 149,344     
|Permanent differences                                                                   |   | 1,702,828    |   | (128,003)    |                       | 618,992     
|Equity
    in net loss of significantly influenced company                              |   | 154,095      |   |             |                       |            
|Loss
    on dissolution of subsidiaries                                                 |   |             |   |             |                       | 1,159,877   
|Impairment of note receivable                                                           |   | 22,648       |   | 84,050       |                       | 677,400     
|Unrecognized recoveries on losses                                                       |   |             |   | (5,774)      |                       | (2,619,798) 
|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
    ememption                                                                       |   | 161,635      |   |             |                       |            
|Other                                                                                   |   | (56,736)     |   | 256,037      |                       | 320,811     
|Valuation allowance                                                                     |   | 2,559,078    |   | 2,002,561    |                       | 751,754     
|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
|Capital assets                                                                          | $ | 268,247      | $ | 206,932      | $                     | 102,294     
|Software development costs                                                              |   | (680,084)    |   | (636,633)    |                       | (496,898)   
|Deferred revenue                                                                        |   | (102,014)    |   | 322,027      |                       |            
|Share
    issue costs                                                                   |   | 84,767       |   | 154,899      |                       | 181,667     
|Other                                                                                   |   | (337,855)    |   | 32,843       |                       | 73,892      
|Loss
    carry forwards                                                                 |   | 19,006,279   |   | 18,220,277   |                       | 18,997,435  
|Valuation allowance                                                                     |   | (18,413,740) |   | (18,300,345) |                       | (19,063,438)
|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.

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.

- 20 -

---

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



12.     Impairment of note receivable.

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 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.

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. The Company continues to defend the action on behalf of one of its
customers.

- 21 -

---

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



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, 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 such orders and acknowledgement will be the effective date of the
Settlement Agreement (the "Effective Date"). The Effective Date must occur
within 120 days of the date of execution of the Settlement Agreement. In
addition, as of the Effective Date, the Receiver, the Company and the Company's
current and certain former directors have agreed to deliver mutual releases.

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) | $ |         | $ |       

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:

- 22 -

---

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



|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.

Through its e-Learning business segment which includes equity
interest in Archer and, the Company is indirectly involved in e-Learning
technology, content and customer service as well as educational content and
distribution channels to offer learning management systems, interactive online
courses and network education solutions to meet diverse client requirements.
Archer provides personal and organizational teaching and learning through
Canadian based schools as discussed in note 4 and 10.

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:

- 23 -

---

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



|                                                           | Revenue                                           |                   |       |              |    
|---------------------------------------------------------- | ------------------------------------------------- | ----------------- | ----- | ------------ | ---
|                                                           | Royalty, license
 and
    implementation
    fees | Other
    product | Total | Amortization | VAT
|                                                          
|                                                          
|                                                          
|2006                                                       |                                                   |                   |       |              |    
|Zi Technology                                              | $                                                 | 11,836,217        | $     |             | $  
|e-Learning                                                 |                                                   |                  |       | 555,523      |    
|Corporate                                                  |                                                   |                  |       |             |    
|Total                                                      | $                                                 | 11,836,217        | $     | 555,523      | $  
|Interest
    expense and interest and other income         |                                                   | 218,588          
|Equity in
    net loss of significantly influenced company |                                                   | (893,973)        
|Impairment of note receivable                              |                                                   | (129,417)        
|Loss before income taxes                                   | $                                                 | (10,109,800)     
|                                                           |                                                   |                   |       |              |    
|2005                                                       |                                                   |                   |       |              |    
|Zi Technology                                              | $                                                 | 10,614,043        | $     |             | $  
|e-Learning                                                 |                                                   |                  |       | 770,470      |    
|Corporate                                                  |                                                   |                  |       |             |    
|Total                                                      | $                                                 | 10,614,043        | $     | 770,470      | $  
|Interest
    expense and interest and other income         |                                                   | 360,504          
|Minority Interest                                          |                                                   | (23,920)         
|Loss before income taxes                                   | $                                                 | (4,629,908)      
|                                                           |                                                   |                   |       |              |    
|2004                                                       |                                                   |                   |       |              |    
|Zi Technology                                              | $                                                 | 12,898,838        | $     |             | $  
|e-Learning                                                 |                                                   |                  |       | 504,213      |    
|Corporate                                                  |                                                   |                  |       |             |    
|Total                                                      | $                                                 | 12,898,838        | $     | 504,213      | $  
|Interest expense and interest and
    other income         |                                                   | 72,153           
|Loss before income taxes                                   | $                                                 | ( 2,388,199)     

|                  |  |                     |                   |                         
|----------------- |  | ------------------- | ----------------- | ------------------------
|                  |  |                     | 2006              | 2005                    
|                  |  | Capital 
    assets | Other 
    assets | Identifiable 
    assets
|                 
|Zi
    Technology |  |                     | $                 | 4,094,355               
|e-Learning        |  |                     |                   |                        
|Corporate         |  |                     |                   | 233,456                 
|Total             |  |                     | $                 | 4,327,811               

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                                      |               |       |              |     |                          |                                                              |           |  
|------ | -------------------------------------------- | ------------- | ----- | ------------ | --- | ------------------------ | ------------------------------------------------------------ | --------- | -
|       | Royalty, license and implementation
    fees | Other product | Total | Amortization | VAT | Other operating expenses | Operating profit (loss) before interest and other
    income
|2006   |                                              |               |       |              |     |                          |                                                              |           |  
|Canada | $                                            | 5,832,869     | $     | 378,230      | $   | 6,211,099                | $                                                            | 1,417,419 | $
|China  |                                              | 4,751,684     |       | 177,293      |     | 4,928,977                |                                                              | 101,944   |  
|U.S.A. |                                              | 935,956       |       |             |     | 935,956                  |                                                              | 6,606     |  
|Sweden |                                              | 315,708       |       |             |     | 315,708                  |                                                              | 169,160   |  
|Other  |                                              |              |       |             |     |                         |                                                              | 14,396    |  

|Total                                                      | $ | 11,836,217 | $ | 555,523 | $ | 12,391,740 | $ | 1,709,525 | $ | 595,157 | $ | 19,392,056 | $ | (9,304,998)  
|---------------------------------------------------------- | - | ---------- | - | ------- | - | ---------- | - | --------- | - | ------- | - | ---------- | - | -------------
|Interest expense and interest and
    other income         |   | 218,588   
|Equity in net loss of significantly
    influenced company |   | (893,973) 
|Impairment of note receivable                              |   | (129,417) 
|Loss before income taxes                                   |   |            |   |         |   |            |   |           |   |         |   |            | $ | ( 10,109,800)

- 24 -

---

Notes to the
Consolidated Financial Statements
For 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    | $ | 45,717         | $    | 4,221,051    | $ | 909,599      | $ |               | $ | 6,869,298    | $ | (3,557,846) 
|China                                              |   | 5,019,599    |   | 724,753        |      | 5,744,352    |   | 59,836       |   | 522,278        |   | 4,278,221    |   | 884,017     
|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   | $ | 770,470        | $    | 11,384,513   | $ | 1,162,119    | $ | 522,278        | $ | 14,666,608   | $ | (4,966,492) 
|Interest expense and interest and
    other income |   | 360,504     
|Impairment of note receivable                      |   | (23,920)    
|Loss before income taxes                           | $ | (4,629,908) 
|                                                   |   |              |   |                |      |              |   |              |   |                |   |              |   |             
|                                                   |   |              |   |                |      |              |   |              |   |                |   |              |   |             
|2004                                               |   |              |   |                |      |              |   |              |   |                |   |              |   |             
|Canada                                             | $ | 5,884,396    | $ | 8,120          | $    | 5,892,516    | $ | 785,332      | $ |               | $ | 9,087,566    | $ | (3,980,382) 
|China                                              |   | 5,207,579    |   | 496,093        |      | 5,703,672    |   | 111,477      |   | 434,386        |   | 3,436,397    |   | 1,721,412   
|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   | $ | 504,213        | $    | 13,403,051   | $ | 926,886      | $ | 434,386        | $ | 14,502,131   | $ | (2,460,352) 
|Interest expense and interest and
    other income |   | 72,153      
|Loss before income taxes                           | $ | ( 2,388,199)
|                                                   |   |              |   |                |      |              |   |              |   |                |   |              |   |             
|                                                   |   |              |   |                |      |              |   |              |   |                |   |              |   |             
|                                                   |   |              |   | 2006           | 2005
|                                                   |   |              |   |                |      |              |   | Identifiable |   |                |   |              |   | Identifiable
|                                                   |   |              |   | Capital assets |      | Other assets |   | assets       |   | Capital assets |   | Other assets |   | assets      
|Canada                                             |   |              | $ | 2,803,787      | $    | 4,637,029    | $ | 7,440,816    | $ | 3,534,976      | $ | 11,044,847   | $ | 14,579,823  
|China                                              |   |              |   | 192,608        |      | 5,059,157    |   | 5,251,765    |   | 198,330        |   | 5,181,836    |   | 5,380,166   
|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   | $ | 5,045,827      | $ | 17,358,678   | $ | 22,404,505  

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:

- 25 -

---

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



|Accounts payable
    and accrued liabilities |   | 2006      |                         | 2005     
|-------------------------------------------- | - | --------- | ----------------------- | ---------
|                                             |   |           | (restated  see note 3)
|Compensation                                 | $ | 1,285,652 | $                       | 1,275,824
|Trade accounts
    payable                   |   | 1,174,585 |                         | 1,529,348
|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    |                         | 117,309  
|Total                                        | $ | 4,046,022 | $                       | 4,547,725

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 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.

- 26 -

---

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



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.









- 27 -

---



REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS

To 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 Difference" referring to
conditions and events that cast substantial doubt on the Company's ability to
continue as a going concern); 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, 2007

Schedule 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  

- 28 -

---