I emailed the developer about this and they replied that it was due to a change in how the new webOS versions save photos. They implied that they would fix it but didn't say when. I came up with the following workaround, but it's ugly:

1) On your PC, use a photo editing program to resize the photos containing your contacts to original height and 2/3 of original width. You are compensating for what PhotoDialer will later do to fatten the images.

2) Copy the slimmed-down photos to your Palm.

3) Open one of the slimmed-down photos. Click "Assign to contact" and crop the photo so the width is what you really want, and the top and bottom of the image that you want extend a little above and below the crop area. (Imagine that the crop area extends 25% above and 25% below the square crop area that you see.)

4) Go to PhotoDialer and add the contact. PhotoDialer will use more of the height than you actually cropped in step 3, and will fatten the image to be square again.

5) Now, go back to your photos and reassign a regular (not distorted) image to your contact so that it will look normal everywhere else. PhotoDialer will keep what it used in step 4.

Fun, huh?