Management's Discussion and Analysis of Financial
Condition and Results of Operations

This discussion and analysis of financial condition and results of operations for the three month period ended March 31, 2005 was made on May 12, 2005 and should be read in conjunction with the unaudited interim consolidated financial statements and related notes in this report. Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") has been prepared with reference to the Company's unaudited interim consolidated financial statements and notes which have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP") and reconciled to Canadian generally accepted accounting principles ("Canadian GAAP"). All financial information herein is presented in United States of America dollars ("US Dollars") except as otherwise indicated. Historically, the primary consolidated financial statements of Zi Corporation (the "Company" or "Zi") have been prepared in accordance with Canadian GAAP and Canadian Dollars with an annual reconciliation of the Company's financial position and results of operations to US 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 their users, who are in the United States, for the period ending December 31, 2003, the Company initiated reporting its financial position, results of operations and cash flows under US GAAP in its consolidated financial statements. Effective March 31, 2004, the Company initiated reporting its consolidated financial statements in US dollars, with comparative periods restated to US dollars. Other revisions to disclosures throughout the Company's consolidated financial statements and notes have been made to comply with US GAAP requirements, including comparative disclosures. The effects on net loss arising from differences in GAAP between the US and Canada are outlined in note 12 to the consolidated financial statements. Forward Looking Information This MD&A contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these forward looking statements when you see words such as "expect", "anticipate", "estimate", "believe", "may", "potential", "intends", "plans" and other similar expressions or statements that an action, event or result "will", "may", "could" or "should" be taken, occur or be achieved, or the negative thereof or other similar statements. These statements are only predictions and involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance, or achievements expressed or implied by these forward-looking statements. These factors include, among others, those listed in "Risk Factors" below. Forward-looking statements are based on the beliefs, opinions and expectations of our management on the date the statements are made. Although we believe that the forward-looking statements presented in this document are reasonable, we do not guarantee that they accurately or completely predict, reflect or state future results, levels of activity, performance, achievements or occurrence and we do not assume responsibility for failure to do so. We do not promise to update forward-looking information to reflect actual results, new information, occurrence of future events, or changes in management's beliefs, opinions or expectations. No undue reliance should be placed on such forward-looking statements. Overview Zi Corporation is incorporated under the Business Corporations Act of Alberta. Principally, Zi develops software designed to enhance the usability of mobile and consumer electronic devices. Through its e-Learning business unit which includes Oztime, English Practice and an equity interest in Magic Lantern Group, Inc. ("MLG"), the Company is also involved in e-Learning technology, content and customer service as well as educational content and distribution channels to offer learning management systems, interactive online courses and network education solutions to meet diverse client requirements.

Summary of Results of Operations
Three months ended March 31 (thousands except per share amounts) (unaudited)	2005		2004
Revenue	$	2,870	$	3,029
Gross margin		2,717		2,913
Net loss	$	(1,514)	$	(1,457)
Total assets	$	23,508	$	9,883
Net loss per share - basic and diluted	$	(0.03)	$	(0.04)
Outstanding shares, weighted average		45,837		39,375
Outstanding shares, end of period		46,225		39,493

      Zi Corporation 2005 3

 

Zi Corporation is a global technology company that delivers intelligent interface solutions to enhance the user experience of wireless and consumer technologies. Zi's product innovations are available on mobile phones, PDAs, gaming devices and set-top boxes. Zi solutions are designed to dramatically improve the usability of these devices and the applications on them; including, SMS, MMS, e-mail and Internet browsing. The company provides device manufacturers and network operators with a full range of intuitive and easy-to-use solutions, including: eZiText® for one-touch predictive text entry; eZiTap™ for intelligent multi-tap entry, Decuma® for natural handwriting recognition and the recently announced Qix™ service discovery engine to enhance the user experience and drive service usage and adoption. Zi's product portfolio includes 48 different language databases, 70 additional language interfaces and the ability to meet user needs in more than 130 countries. With over 100 handset manufacturing customers, Zi's technologies can be found in the handsets of manufacturers from around the world, including Nokia, Sony, Sony Ericsson, Samsung, LG Electronics, Flextronics, HP, Sanyo, Fujitsu, Kyocera and others. In early 2005, Zi acquired Decuma handwriting recognition technology and announced the Qix service discovery engine to Zi's core predictive text solutions of eZiText and eZiTap. With this expanded portfolio of products, Zi is focused on making mobile devices smarter and easier to use with software products that simplify data entry and interaction on a communications device. The combination of the technologies is expected to further bolster Zi's competitive advantage and enable Zi to deliver an expanded suite of innovative products to customers. Critical Accounting Policies and Estimates The preparation of these consolidated financial statements and related disclosures in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of these financial statements, and revenue and expenses during the period reported. Estimates include allowance for doubtful accounts, valuation of the note receivable, estimated useful life of intangible assets, deferred costs and capital assets; provisions for contingent liabilities; measurement of stock-based compensation; valuation allowance for future tax assets; and revenue for other product revenue using the percentage of completion method, and reflect management's best estimates. By their nature, these estimates are subject to uncertainty and the effect on the financial statements of changes in estimates in future periods could be significant. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the period that they are determined to be necessary. The allowance for doubtful accounts reflects estimates of doubtful amounts in accounts receivable. The allowance is based on specifically identified accounts, historical experience and other current information. The Company has identified the following critical accounting policies that affect the more significant estimates and judgments used in preparation of its consolidated financial statements. Software Development Costs All research and development costs are expensed as incurred except those that qualify under the Financial Accounting Standards Board Statement ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed". Research and development costs incurred prior to the establishment of the technological feasibility of a particular software project are expensed as incurred. Software development costs, including costs associated with coding and testing of project related software, are capitalized subsequent to when the technological feasibility of a project is established. Capitalized costs are amortized commencing in the period of the product's commercial release. The determination of whether a project is technically feasible involves establishing, at a minimum, that the Company has a detailed, documented and consistent product and program design, including high risk development issues related to the project, with the necessary resources to complete the project. If a detailed program design is not used, technological feasibility will be established when a product design or working model of the software model, consistent with the product design, is complete and tested. Revenue Recognition The Company recognizes revenue when it is earned and realized in a manner consistent with interpretations in Staff Accounting Bulletin No. 104 of the US Securities and Exchange Commission as further described in note 2 to the Company's annual consolidated financial statements. Revenue from licensed software is recognized in accordance with Statement of Position ("SOP") 97-2, "Software Revenue Recognition". Revenues from software licensing royalties related to the sale of the product in which the Company's technologies have been embedded are recorded as earned. Software licensing royalties are included in fees from licensing and implementation. Under software licensing arrangements, the Company recognizes revenues provided that: a license agreement has been signed and fees are non-refundable; the software and related documentation have been delivered; there are no uncertainties regarding customer acceptance; collection of the resulting receivable is deemed probable; the fees are fixed and determinable; and no other significant vendor obligations exist. Any revenue associated with contracts having multiple elements is deferred and recognized ratably over the period of the contract unless clear evidence exists with respect to the fair value of each separate element of the contract. Fair value for each separate element is evidenced by existing customer 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.

4 FIRST QUARTER REPORT

Customer support revenues consist of revenue derived from contracts to provide post contract support, such as maintenance and service support, to license holders. The revenues are recognized ratably over the term of the contract. Revenue from Oztime product contracts recorded in other product revenue is recognized using the percentage of completion method, whereby revenue is recorded at the estimated realizable value of work completed to date and costs incurred to date are compared to total estimated contract costs to determine whether a loss will be realized. Amounts received in advance are recorded as deferred revenue. Estimated losses on contracts are recognized when they become known. Other product revenue recorded by the Company is mainly comprised of revenue for the e-Learning business segment and this revenue is recognized through the percentage of completion method as previously described. Stock-based Compensation Plan As permitted under SFAS No. 123, "Accounting for Stock-Based Compensation", regarding the accounting for the grant of employee and director stock options, the Company has elected to use the intrinsic value method, following Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Under APB No. 25, companies are not required to record any compensation expense relating to the grant of options to employees or directors where the awards are granted upon fixed terms with an exercise price equal to fair value at the date of grant and the only condition of exercise is continued employment. The Company accounts for restricted stock units ("RSU's") in accordance with SFAS No. 123, whereby the intrinsic value method is used and the related compensation expense is recognized over the vesting period. The Company has a stock-based compensation plan, which is further described in note 9 to the Company's annual consolidated financial statements. The Company has elected to account for stock options by measuring compensation expense as the excess, if any, of the quoted market value of the stock at the date of grant over the exercise price. Any consideration paid by employees on exercise of stock options or purchase of stock is credited to share capital. If stock or stock options are repurchased from employees, the excess of the consideration paid over the carrying amount of the stock or stock option cancelled is charged to retained earnings. Three Months Ended March 31, 2005 Revenue Total revenue for the three-months ended March 31, 2005 was $2.9 million, a decrease of 5 percent or $0.2 million compared to the first quarter revenue a year earlier. Revenue from Zi Technology and its text input applications was $2.7 million compared to $3.0 million for the same period a year ago. Revenue from two customers represented a decline of $0.6 million on a year over year basis. Of the two customers, one is no longer a customer, representing a $250,000 decline in revenue and the other contributed $0.3 million less revenue year over year due to a shrinking market for a particular mobile technology. Otherwise, the Company's revenue from all other customers increased by $0.3 million or 14 percent. Other product revenue from e-Learning was $0.2 million for the quarter compared to $59,000 a year earlier. In this quarter, Zi earned royalties from 44 eZiText licensees compared to 43 in the same period a year earlier. In the three months ended March 31, 2005, 56 new handset models embedded with eZiText were released into the market, bringing the total as of that date to 860 compared to 482 a year earlier. Gross margin on revenue was $2.7 million for the first quarter of 2005, a decrease of seven percent from last year's level of $2.9 million. Gross margin this quarter is relatively unchanged at 95 percent of revenue compared to 96 percent in the first quarter of the prior year. Operating Costs and Expenses Selling, general and administrative expense ("SG&A") for the three months ended March 31, 2005 was $2.8 million compared to $3.3 million for the three months ended March 31, 2004. Selling costs increased by $0.6 million in the first quarter of 2005 compared to the same quarter in the prior year principally as a result of costs to introduce Qix to the market. SG&A costs also include $0.1 million due to costs associated with operations of the newly acquired Decuma handwriting recognition technology and $0.2 million of professional fees related to Sarbanes Oxley and other regulatory compliance. In the first quarter of 2004, $1.4 million in non-cash compensation expense was recognized upon issuance of restricted stock units and non-employee stock options. There were no non-cash compensation expenses incurred in this year's first quarter.

     Zi Corporation 2005 5

Product research and development costs relate principally to the development of new, but not yet commercialized products, product and customer support and the ongoing cost of development and enhancement of existing products. Product research and development expense increased to $1.0 million in the first three months of 2005 from $0.7 million from the same period in 2004. This increase is due primarily to product research and development expense of $0.2 million related to Decuma operations. In the three months ended March 31, 2005, gross expenditures on new product development before capitalization were $1.3 million reflecting the Company's development of new language database software and Qix. In the first three months of 2004, the Company's gross expenditure on product research and development was $0.7 million. The Company capitalized $0.3 million in the first quarter of 2005 versus $3,380 in the same quarter of 2004. Depreciation and amortization increased by $0.1 million in the first quarter of 2005 compared to the same period a year earlier. The increase in depreciation and amortization is due to the increase in amortization of software development costs related to development of new products and amortization of patent, customer agreements and trademark costs purchased from Decuma. Net loss was $1.5 million for the three-month periods in both 2005 and 2004. The net loss in the current period includes: $0.6 million operating loss from the Zi Technology business segment; $0.3 million loss from the e-Learning business segment; and $0.8 million loss for other corporate costs including public company operating costs. Compared to the same period a year earlier, the Zi Technology segment operating profit decreased $1.3 million from $0.7 million to a segment operating loss of $0.6 million. This is due to the increase in the first three months of 2005 in selling costs of $0.6 million and increased product research and development costs of $0.3 million, increased legal costs of $0.1 million and Decuma related costs as described above. Liquidity and Capital Resources At March 31, 2005 Zi had cash and cash equivalents of $15.9 million. The objective of Zi's investment policy for funds is to preserve capital and maintain short-term liquidity while earning reasonable investment returns. During the past three years, Zi's cash requirements have been met through revenues from operations, proceeds from issuance of common shares through private placements and the exercise of common share purchase warrants and options. During the three months ended March 31, 2005, the Company had net cash inflow of $3.0 million mainly represented by $3.1 million in working capital generated through the collection of significant outstanding receivables, receipt of proceeds from the exercise of warrants and stock options of $2.2 million, offset by a net loss of $1.5 million less depreciation of $0.3 million, the investment in Decuma of $0.5 million and the investment in software development costs of $0.3 million. Cash flow from operations for the first three months of 2005 was $1.9 million as compared to cash applied to operations of $0.4 million for the same period in 2004. Included in the $0.4 million of cash applied to operations in 2004 was $0.75 million representing the final scheduled installment under a settlement agreement with AOL America Time Warner ("AOL"). Excluding the AOL final payment, cash flow from operations was $0.34 million. The net increase of $1.5 million in cash flow from operations between the two quarters represents, principally, decreased gross margin of $0.2 million, increased SG&A costs of $1.0 million (the 2004 comparative period costs exclude non-cash compensation expense of $1.4 million), increased product research and development cost of $0.3 million and increased litigation and legal of $0.1 million, offset by decreased non-cash working capital of $2.9 million. On January 26, 2005, the Company purchased the assets of Decuma AB, a Swedish company specializing in developing and marketing handwriting recognition software. The Company has accounted for the purchase under the purchase method of accounting. As part of the acquisition, the Company acquired Decuma's intellectual property and customer agreements. 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. Capital requirements for the remainder of 2005 include costs to carry Oztime until its divestiture, funding of continued new product development and enhancements to existing products and funding Decuma operations. At current revenue and expense levels, the Company is able to fund its continued operations and meets its current obligations. Litigation/Indemnification On December 4, 2003, the Company commenced a legal action against prior counsel in respect of, among other things, their representation of the Company in a lawsuit, the outcome of which was unfavourable to the Company. As part of its defence to the Company's action, prior counsel filed, a cross complaint against the Company for $1.1 million in unpaid legal fees, which has been accrued by the Company. On April 16, 2005 the Company settled this litigation against prior counsel. As a result, the Company will realize a non-recurring gain, net of legal fees incurred by the Company to pursue this action, of approximately $1.5 million. The settlement will be reflected in the financial statements for the three months ended June 30, 2005.

6 FIRST QUARTER REPORT

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 the Company does not anticipate or foresee at this time any new intellectual proceedings being instigated by other parties against Zi or by Zi against other parties, there is no assurance that Zi's legal costs or legal actions will significantly diminish in the future. The Company does 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, Zi's legal costs in respect of these actions may increase or maintain current levels if any judgement or determination is appealed or otherwise progresses though the legal process. Moreover, given the extremely competitive nature of Zi's eZiText business and the wide scope of intellectual property covering the text input space, there can be no assurance that in the future, the Company, or any of Zi's licensees, will not be continually subject to allegations concerning the status or validity of Zi's intellectual property. Related Party Transaction In April 2005, the Company advanced $250,000 under a secured loan agreement to MLG. The terms of the agreement require repayment on demand and provide the Company with a security interest in the assets of MLG. The Company will evaluate the note for impairment, if any, and the effect of providing financial support to a significantly influenced subsidiary in the second quarter of 2005. Risk Factors Important risk factors that could cause actual results, performance or achievements to be materially different from those expressed or implies by these forward-looking statements include: •  Zi's history of operating losses and uncertainty of future profitability;
•  uncertainty as to the degree of and continuing market acceptance of Zi's products and services;
•  uncertainties relating to product development;
•  risks associated with the number, amount and timing of new product introductions; •uncertainty regarding patents, proprietary rights and software piracy;
•variability in customer demand;
•our dependence on third party performance under marketing and licensing arrangements;
•risks associated with the contingent nature of continued performance under major sales contracts;
•rapid technological change and competition;
•uncertainty regarding the pricing, reporting and collection of accounts;
•uncertainties related to dependence on third-party suppliers;
•risks associated with dependence on sales in foreign countries;
•the potential for adverse developments in pending litigation;
•risks related to indemnity claims from third parties;
•risks associated with the terms of settlement agreement and permanent injunction in respect of a US patent infringement lawsuit;
•fluctuations in foreign exchange rates;
•uncertainties associated with changes in government policy and regulation, particularly in the People's Republic of China ("PRC" or "China");
•adverse changes in general political, economic, business, regulatory and legal conditions in any of the countries in which the Company does business;
•changes in Zi's size and structure;
•risks associated with mergers, acquisitions and dispositions;
•risks of dilutive future financings;
•the effectiveness of Zi's management and Zi's strategic relationships,
•investment risks associated with Zi's e-Learning investments;
•the negative publicity generated by the Lancer proceedings or general market concerns about the possible actions by the receiver with respect to portfolio securities held by Lancer;
•other risks and uncertainties that may be disclosed in the Company's various corporate disclosure documents from time to time, and:
•other risk factors detailed from time to time in the Company's periodic reports filed with the US Securities and Exchange Commission and other regulatory authorities.

     Zi Corporation 2005 7