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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

OR

FOR THE TRANSITION PERIOD FROM              TO             

COMMISSION FILE NUMBER: 0-9023

COMDIAL CORPORATION

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (941) 554-5000

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

TITLE OF CLASS COMMON STOCK (PAR VALUE $0.01 EACH)

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.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2003, was approximately $8,449,347 (See Item 5). The number of shares of Common Stock outstanding as of March 19, 2004, was 8,974,560.

DOCUMENTS INCORPORATED BY REFERENCE: Portions of Comdial’s Definitive Proxy Statement for its 2004 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2003, are incorporated by reference under Part I, Item 5 and Part III of this Form 10-K. Portions of Comdial’s Schedule 14C Definitive Information Statement dated October 27, 2003, are incorporated by reference under Part I, Item 4 of this Form 10-K.

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PART I

ITEM 1. BUSINESS

GENERAL DEVELOPMENT OF BUSINESS

Comdial Corporation (“Comdial” or the “Company”) is a Delaware corporation based in Sarasota, Florida. Comdial was originally incorporated in Oregon in 1977 and was reincorporated in Delaware in 1982 when it acquired General Dynamics Telephone Systems Center, Inc. (formerly known as Stromberg-Carlson Telephone Systems, Inc.), a wholly owned subsidiary of General Dynamics Corporation. Comdial’s common stock is quoted on the Over the Counter Bulletin Board under the symbol “CMDZ”.

Comdial(R) designs and markets sophisticated voice communications solutions for small to mid-sized offices. Comdial’s products consist of business telephone systems, unified and voice messaging, call processing, and computer telephony integration solutions. Comdial has shipped approximately 400,000 business phone systems and 4 million telephones.

As part of our restructuring program, we have outsourced substantially all of our manufacturing requirements. Outsourced manufacturing is carried out in three principal locations: Asia, Mexico and the United States. During June 2003, Comdial purchased the technology and assets of Soundpipe Inc. (“Soundpipe”). Soundpipe was primarily engaged in the design and development of communication solutions utilizing voice over Internet Protocol (“VoIP”) technology and the acquisition enhanced Comdial’s development efforts in this area.

Industry Background

Comdial’s primary product offerings fall into three categories: (1) voice switching systems, (2) voice messaging systems, and (3) computer telephony integration (“CTI”) applications that incorporate voice messaging and voice processing products with advanced computer technologies and VoIP applications. All of these products are focused on small- to medium-sized offices, are highly competitive and are influenced by trends and events in technology, regulation and the general economy.

Voice Switching Systems

Comdial produces and markets digital voice switching systems known as key/hybrid systems. Historically, voice-switching systems were categorized as either key/hybrid systems or Private Branch Exchanges (“PBXs”). Key/hybrid systems are typically purchased by small- to medium-sized offices of small to large organizations with 3 to 500 employees per location or branch office, while larger businesses with more than 500 employees in one location typically purchase PBXs. However, design advances in key/hybrid systems and PBXs in recent years have blurred the distinction between the two systems. As key/hybrid systems continue to evolve, they increasingly encroach on the domain of the traditional PBXs, and vice versa.

A basic business telephone system consists of: (a) a central switching unit, (b) telephone instruments, (c) associated wiring and connection hardware, (d) system software, and (e) adjunct devices such as facsimile machines and voice processing systems. Voice switching systems are measured in terms of “ports”. A port is an access point on the switch to an outside trunk or terminal device. Examples of terminal devices include telephones, facsimile machines, modems, and voice mail ports. Examples of trunks include standard business lines and digital lines such as ISDN and T-1, as well as other types of circuits provided by a telephone company or an alternative service provider. With the proliferation of modems, facsimile machines, and voice mail systems, the demand for port capacity in key/hybrid systems has grown.

Due to the voice and data convergence phenomenon, data access to VoIP networks and the Internet as a type of access point is becoming increasingly important in voice switching systems. As part of this technology change, the emergence of IP-based terminal devices such as IP telephones is becoming an important component in the Company’s product portfolio. Data access points are available for trunks, terminal devices and networking. The Company accomplishes this with an IP media board that supports VoIP protocols. The Company product portfolio includes an IP telephone.

The key/hybrid segment of the voice switching market, as reported by Phillips Infotech (InfoTrack for Enterprise Communications, Third Quarter 2003 Report), was forecasted at 3.9 million system line shipments in 2003, representing a 15.3 percent decline from 2002. For the nine months ended September 30, 2003 actual system line shipments in this segment declined by 11 percent. During this same period, Comdial key/hybrid shipments decreased by 4 percent to 202,000, resulting in a market share of 6.4 percent in such period–a 29 percent increase versus the same period in 2002. The Company was ranked sixth in market share behind NEC, Avaya, Nortel, Toshiba, and Panasonic Company during the period. Year-end data for 2003 is not yet available.

The domestic demand for traditional key/hybrid switching systems, as projected by Phillips Infotech, is expected to increase 2.1 percent, remain flat, and decrease 2.4 percent in 2004, 2005, and 2006, respectively. Phillips Infotech also reports that the key/hybrid market end-user spending is projected at approximately $1.16 billion, $1.14 billion, and $1.11 billion in 2004, 2005, and 2006, respectively.

The IP PBX switching market in terms of line shipments is expected to grow 35.4 percent, 23 percent, and 25 percent in 2004, 2005, and 2006, respectively. This projected growth translates into end-user spending of approximately $2.39 billion, $2.92 billion, and $3.62 billion in 2004, 2005, and 2006, respectively.

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The projected declines in the key/hybrid and PBX markets are primarily due to the adoption of IP PBX systems. In 2001, Comdial gained market share in the key/hybrid market and started selling in the emerging IP PBX segment. The Company believes it is well positioned to compete effectively in both markets. The Company’s FX II product is classified as a converged IP telephony system and provides customers with the option of deploying circuit switched and/or packet switched solutions.

Voice Messaging Systems

Comdial voice processing products service a broad range of customer applications ranging in size from 2 to 64 ports. Comdial’s primary voice messaging product sales are in the 2 to 8 port range, corresponding with the needs of small to mid-size offices that are Comdial’s primary markets. Interchange^™, in combination with Corporate Office, Comdial’s mid- market offering, and Debut^®, its entry-level product, constitute a complete range of voice processing solutions.

As the market for voice processing systems has matured, a new variation known as “unified messaging” (“UM”) has evolved. UM provides a means of storing voice messages along side email messages in a single location (such as the “inbox” associated with Microsoft^® Outlook^® in-box). UM enables a system user to play voice mail messages (using the sound capabilities of their PC) at the same time the user is picking up their email messages. The user can also annotate, store and forward voice messages in the same manner as e-mail messages. UM also allows the user to listen to voice messages via the telephone and also listen to e-mail messages via the telephone through the use of text-to-speech software. The UM “in-box” is a multimedia store for voice and e-mail messages. In 1999, Comdial introduced Interchange, its unified messaging (UM) system combining voice mail and e-mail. Comdial’s Interchange UM system is available in several sizes and integrates with Microsoft Exchange and other popular e-mail servers.

The voice messaging market end-user spending for 2003, according to Phillips Infotech, was estimated at $2.33 billion, down from $2.35 billion in 2002. While system shipments are expected to grow about 3 to 5 percent annually, revenue is projected to remain relatively flat over the next three years due to lower prices.

Computer Telephony Integration Solutions

Comdial has also developed sophisticated desktop software applications designed to run in a Microsoft Windows^®/Outlook environment. Examples of these applications include Impact Attendant^™, Impact Group^™, and Impact Call^™. All of these applications enable a PC user to visually monitor and control (transfer, hold, etc.) phone calls. The call control capabilities of these desktop applications are enabled by Comdial’s “Enterprise” CTI link and WideOpen Office^®, a server based program. The market for CTI products is very diverse and difficult to quantify. Most of Comdial’s CTI sales derive from sales of the Company’s switching and/or voice messaging products.

Strategy

Comdial seeks to expand sales and profits by:

Product Offerings

Comdial currently offers complete business communications solutions consisting of bundled platforms, traditional and converged switching systems, desktop and wireless phones, voice and unified messaging systems, and computer telephony integration software.

Converged Telephony Platform

In 2002, Comdial introduced the Converged Telephony Platform^™ package to bring about awareness of Comdial’s suite of products. This product strategy was aimed at increasing average selling prices by promoting the advantages of the FX II and Interchange solution set. The Platform combines the features of Comdial’s FX II Business Communications System, Interchange Unified Messaging, and the Impact Attendant CTI application. The Converged Telephony Platform received an Internet Telephony “2003 Product of the Year” award.

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Switching

The Company’s switching products consist of its business phone systems (FX II and DX-80), telephones (Impact, iPrimo, Scout II), and other switching-related products.

FX II Business Communications System

The FX II, a rackable switch that is expandable to 560 ports, is Comdial’s most current switching platform. It can function as a key hybrid or PBX and offers more scalability and configurability than any of Comdial’s other switching platforms. The FX II is expandable to 5 cabinets. FX II supports fiber connectivity, IP networking, and IP telephones. The FX II is intended to bridge legacy circuit-switched telephony with packet-switched telephony. The rack mount design is intended to provide a more convenient installation option.

As noted above, the FX II supports fiber connectivity, which provides a fiber optic link between cabinets for installation environments that can benefit from multiple cabinets in the same application, but which may be separated by up to 2,500 meters. Typical applications for fiber connectivity are campus environments and multi-level buildings.

The FX II’s T-1 & PRI IP networking capabilities allow multiple locations to share one numbering plan and feature transparency. By utilizing the TCP-IP protocol, users are able to use less expensive carrier options like frame relay to connect their locations. The same IP connection that is used for voice can also be used for data, thus potentially providing additional cost savings. The FX II IP networking option enables the use of different voice compression algorithms to fit different user applications and bandwidth requirements.

DX-80 Small Business Phone System

Comdial’s OEM key system is the DX-80. At a maximum of 16 trunks and 48 digital phones, the DX-80 provides an advanced feature set (including an internal voice processing capability) at a lower price to the end user. The lower price of the DX-80 is intended to allow Comdial to increase sales into the traditional key system market.

Phones

Comdial provides the Impact SCS phone for use with the FX. Impact SCS provides advantages such as a larger screen LCD and full-duplex transmission. The DX-80 utilizes its own digital telephone and is also available to all dealers.

Comdial also offers the iPrimo SCS, an IP version of the SCS digital feature phone for use with FX II. This IP phone enables remote workers to use an IP connection to an FX II switch with access to many of the same desktop features available on an SCS phone. As with IP networking, the IP phone will allow businesses to utilize their WAN data networks to carry corporate voice traffic, thereby potentially reducing costs associated with their circuit switched voice networks.

Comdial offers a wireless office phone, Scout II. The Scout II offers a smaller and lighter form-factor coupled with longer range when compared with prior Comdial offerings. The Scout II wireless telephone is exclusively designed for use with Comdial business phone systems and is intended for use when a land-line phone is not available. The Scout II utilizes a Digital Spread Spectrum 900MHz frequency.

Messaging

Comdial’s messaging products include unified call processing systems (Interchange) and voice mail systems (Debut and Corporate Office).

Interchange Communications Suite

Interchange, a unified call processing system, provides voice mail, auto attendant, interactive voice response, work group call center support, call recording, and unified messaging and is intended for use in small to mid-sized offices. Interchange is available in several form-factors, can scale from 4 to 64 ports, and supports digital or analog integration.

Interchange’s architecture supports voice mail or unified messaging on a mailbox-by-mailbox basis. Unified messaging is intended to allow users to access and manage all their voice and email messages from the convenience of a single desktop inbox. Interchange users are able to use any telephone to listen to emails, and reply to them with voice mails. Interchange’s notification feature notifies users via mobile phone or pager when messages arrive. Interchange supports local and remote email servers including Microsoft Exchange, Lotus Notes, and Novell Group Wise. For customers that use an application service provider for messaging services, Interchange enables companies to enjoy unified messaging without the added costs and maintenance of an in-house email server.

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Voice Messaging Systems

Comdial offers a number of voice messaging systems such as Debut® and Corporate Office®. These products are scaleable and serve the needs of businesses from very small (2-ports) to large (64-ports). The products provide standard voice processing features such as auto attendant, voice store and forward, multiple greetings, and individual voice mailboxes. Available features include fax tone detection, IVR (interactive voice response to user touch-tone commands), and Visual Call Management (desktop tools to manage call traffic and customize an individual’s messaging environment). Comdial’s voice messaging systems are available in several form-factors including: wall-mount, floor, and rack-mount chassis.

Computer Telephony Integration (CTI)

CTI applications include an automated call distribution system (Quick Q), and a soft-phone attendant console (Impact Attendant).

QuickQ® ACD

QuickQ is Comdial’s automatic call distribution (“ACD”) offering. Quick Q is a server based application intended to control call flow in the FX II and record call history for the purpose of producing ACD supervisor and management reports and real-time displays (on telephone LCDs and reader-boards) of call traffic.

Impact Attendant CTI Console

The Impact Attendant application is a Windows-based, multitasking attendant console. This application is intended to allow attendants to view the status of all calls and extensions for a business or workgroup from any desktop PC. Using a mouse or keyboard, attendants are able to initiate calls to extensions or external numbers or transfer, park, or place incoming calls on hold through the user-interface.

Product Development/New Products

Comdial currently has a number of new products and product enhancements at various phases, many of which are scheduled for release during 2004. Key product initiatives include the following:

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Product Distribution

The majority of Comdial’s products are sold to the end-user through a network of Comdial authorized dealers. The Company has authorized dealers in every major metropolitan area in the U.S. These dealers purchase Comdial products from Comdial-authorized distributors. Use of the distributors enables Comdial to minimize receivables credit risk, sales administration and inventory. The distributors also make Comdial products widely available on a same-day or next- day basis. Comdial dealers benefit from having multiple sources from which they can obtain product on short notice, which keeps down the cost of the product to dealers and minimizes the need for dealers to maintain their own inventory.

Strategic Alliances

Comdial plans to continue to evaluate strategic alliances where it can either generate more customers or enhance its product lines and utilize its distribution power through the dealer channel.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

During the fiscal years ended December 31, 2003, 2002 and 2001, substantially all of Comdial’s sales, net income (loss), and identifiable net assets were attributable to the telecommunications industry. Additional information is included in Note 14 to the consolidated financial statements.

Product Sales Information

The following table presents certain relevant information concerning Comdial’s business segments for the periods indicated:

The significant decrease in messaging revenue in 2003 is primarily due to the product mix. During 2003, there was reduced demand for the Company’s higher priced Corporate Office product, as users are focusing more on voice messaging products that are integrated with the voice switching systems. In addition, as the market for voice processing systems has matured, the competitive marketplace has caused pricing pressures.

NARRATIVE DESCRIPTION OF BUSINESS

Products

Comdial’s recent strategy has been to reduce its product portfolio to fewer product stock keeping units (SKUs). Reducing the number of similar products and focusing on increasing volume and lowering product cost, is intended to improve profit margins in the future. We believe this also enhances the Company’s competitive position.

Comdial offers a variety of communications products, including switching products, messaging systems, CTI solutions and other software applications. Comdial’s telecommunications products meet the requirements of three agencies: (1) the Federal Communications Commission (“FCC”), (2) an independent laboratory approved by the Occupational Safety and Health Act Commission (“OSHA”) to produce safety standards, and (3) a nationally recognized test laboratory that performs product evaluations. Selected products are also registered with the Canadian government and are Canadian safety certified.

Sales and Marketing

Comdial markets its products through both direct and indirect channels. Indirect channels include both one-tiered and two-tier distribution. Comdial’s primary channel of distribution to U.S. and Canadian markets is through three wholesale distributors, which in turn, resell to hundreds of independent dealers.

Three supply houses collectively accounted for more than 86% of Comdial’s net sales. These are ALLTEL Supply, Inc. (“ALLTEL”), Graybar Electric Company, Inc. (“Graybar”), and Sprint North Supply, Inc. (“North Supply”). In 2003, net sales to ALLTEL, Graybar, and North Supply amounted to approximately $8.6 million (18%), $20.9 million (44%), and $11.6 million (24%), respectively.

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Comdial’s dealers are segregated into different levels, based on sales volume. These are Diamond, Platinum, Gold and Associate. Comdial offers special marketing programs for Diamond, Platinum, and Gold dealers, including exclusive access to certain products, market development funds and product credits related to dealer purchase levels, certain territorial protection, toll free technical assistance, and training. All recognized dealers have sales quotas, and Comdial’s sales department monitors their performance against these targets. Comdial supports its existing dealers and seeks to attract new dealers through its web site, direct selling efforts, joint sales activities with distributors, and other new dealer recruitment programs.

Comdial has defined geographic sales territories, each of which include a regional sales manager (“RSM”) who is responsible for recruiting new dealers, as well as managing existing dealers. Dealers are supported through a team of dedicated inside sales representatives, email distribution, and local product seminars often organized by distributors. To stimulate and support demand, each RSM makes joint sales calls with dealers to end-users and trains dealer sales personnel in product benefits. Product specialists at Comdial are available to help design complex configurations and solve technical issues.

Comdial’s dealers sell Comdial’s products to end-users and provide after-sale support, including maintenance services. Comdial maintains a technical staff for dealer technical support. Comdial also generally provides a limited warranty on elements of its products, in most cases up to a maximum of 24 months.

Other indirect channels include OEM relationships, international sales, and dealer direct sales for specific products. International sales for 2003, 2002 and 2001 were less than 1% of total Company net sales.

Engineering, Research and Development

Comdial believes that it must continue to introduce new products and enhance existing products to maintain a competitive position in the marketplace. Comdial’s engineering department, working in collaboration with the marketing and manufacturing departments, is responsible for design of new products and enhancements. Significant amounts of engineering expenditures are dedicated to new product development, with the balance used for cost reductions and performance enhancements to existing products. Comdial strives to ensure research and development resources are spent on projects that provide the best return and have the most strategic value. This may at times mean utilizing resources outside the Company on a contract basis or partnering with other companies to bring products and/or features faster to the market place.

Research and development costs for the fiscal years ended 2003, 2002 and 2001 comprise the majority of engineering, research, and development costs, which were $3.5 million, $5.3 million and $7.6 million, respectively. Comdial is unable to segregate and quantify the amount of research and development costs from other engineering costs for such fiscal years.

Some of the costs associated with the development of product software have been capitalized as incurred. The accounting for such software follows the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 86. The amounts capitalized in 2003, 2002 and 2001 were $2.1 million, $0.7 million and $2.8 million, respectively. The amortization expense of capitalized software development costs in 2003, 2002 and 2001 were $2.4 million, $3.1 million and $3.1 million, respectively.

Manufacturing and Quality Control

Comdial has streamlined its product offerings in 2001, 2002 and 2003 by eliminating products and models that were redundant and/or low volume, thereby simplifying outsourcing and reducing the associated risk. This action also has the added benefit of concentrating more volume on the remaining models, which has had a positive effect on cost, efficiency and quality. The Company believes that outsourcing the manufacturing of its products provides benefits in the form of lower costs, higher margins and competitively priced products. While 2001 and 2002 were predominantly restructuring years for the Company, the outsourcing of the majority of its products has resulted in significant benefits to the Company. The Company has experienced certain disruptions in its supply chain during this process, including some related to defective component parts. The Company believes it has substantially resolved those problems.

Competition

The market for Comdial’s switching and voice-processing products is highly competitive. Comdial competes with over 25 suppliers of small business telephone systems, many of which have significantly greater resources. Examples are Avaya, Nortel Networks, Cisco, 3Com, NEC, Inter-Tel, Vodavi, Panasonic, and Toshiba Corporation. Key competitive factors in the sale of telephone systems and related applications include performance, features, reliability, service and support, name recognition, distribution capability, and price. Comdial believes that it competes favorably in its market with respect to the performance, features, reliability, distribution capability, and price of its systems, as well as the level of service and support that Comdial provides. In marketing its telephone systems, Comdial also emphasizes system expandability, quality, and high technology features including the IP and CTI capabilities of its products.

Comdial expects that competition will continue to be intense in the markets it serves, and there can be no assurance that Comdial will be able to continue to compete successfully in the marketplace or that Comdial will be able to maintain its current dealer network.

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Backlog

In 2002, the Company experienced difficulties in fulfilling certain product orders as a result of the production transition from its own manufacturing in Virginia to the outsourcing partners plus a backlog that had been built up with one of the United States outsourcing partners. These problems have been addressed by changing outsourcing partners. Also in 2002, one principal outsource manufacturer was unable to meet substantially all of our product delivery orders because of financial and operational problems. That inability caused further problems for us in meeting customer orders and resulted in a substantial backlog, potential lost business and other losses. As a result, we were forced to terminate our relationship with that manufacturer and transition that work to other contractors. We filed an arbitration action against that manufacturer in 2002 in order to seek recovery of the losses caused by their failure in performance; this action is still pending. While we believe these problems with these contract manufacturers have been addressed, we cannot give assurances that they will not continue to have an impact on sales and revenues, or that similar or other significant problems will not occur in the future. As of December 31, 2003 and 2002, the backlog was approximately $1.0 million and $4.3 million, respectively.

Intellectual Property

From time to time, Comdial has been subject to proceedings or claims alleging infringement by Comdial of intellectual property rights of third parties. Such matters have required Comdial to expend significant sums in litigation and/or in licensing fees. Moreover, such claims could result in significant damages being assessed against the Company, and/or the requirement to develop non-infringing technology, or acquire additional licenses to the technology that is the subject of the asserted infringement, any of which could have a material adverse effect on Comdial’s business. Moreover, Comdial relies upon copyright, trademark, patents and trade secret protection to protect Comdial’s proprietary rights in its products and processes. There can be no assurance that these protections will be adequate to deter misappropriation of Comdial’s technologies or independent third-party development of potentially infringing technologies.

The business telecommunications industry is characterized by rapid technological change. Industry participants often find it necessary to develop products and features similar to those introduced by others, with incomplete knowledge of whether patent protection may have been applied for or may ultimately be obtained by competitors or others. The telecommunications manufacturing industry has historically witnessed numerous allegations of patent infringement and considerable related litigation among industry participants. As noted above, Comdial itself has received claims of patent infringement from several parties seeking substantial sums and has been sued in federal court for patent infringement. In response to prior infringement claims, Comdial has pursued settlement and/or has obtained nonexclusive licenses entitling Comdial to utilize certain patented technologies or processes that are widely licensed and used in the telecommunications manufacturing industry. These licenses will either expire at the end of the patent license or the end of an agreed-to period. Currently, Comdial is negotiating with certain parties concerning the licensing of patented technologies.

Employees

As of December 31, 2003, Comdial, including subsidiaries, had 146 full-time employees, of whom 5 were engaged in light assembly and testing, 33 in product development (including engineering, product management and technical publications), 55 in sales and marketing (including customer service and support), 31 in operations (including procurement, quality assurance, warehouse and distribution), and 22 in finance, information technology and administration.

Website Access to Reports

The Company makes available free of charge through its internet site, via a link to the EDGAR database of the Securities and Exchange Commission (“SEC”), its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. In addition, you may read and copy any reports, statements, or other information that we file at the SEC’s Public Reference Room at 450 Fifth Street, NW., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

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Safe Harbor Statement Under The Private Securities Litigation Reform Act of 1995

Some of the statements included or incorporated by reference into our Securities and Exchange Commission filings, press releases, and shareholder communications and other information provided periodically in writing or orally by our officers, directors or agents, including this prospectus, are forward-looking statements that are subject to risks and uncertainties. These forward- looking statements are not historical facts but rather are based on certain expectations, estimates and projections about our industry, our beliefs and our assumptions. Words such as “may”, “will”, “anticipates”, “expects”, “intends”, “plans”, “believes”, “seeks” and “estimates” and variations of these words and similar expressions are intended to identify forward-looking statements. Some of the risks and uncertainties include, but are not limited to:

These risks could cause our actual results for 2004 and beyond to differ materially from those expressed, implied or forecasted in any forward-looking statement made by, or on behalf of, us. We undertake no obligation to publicly update or revise the forward-looking statements made in this prospectus to reflect events or circumstances after the date of this prospectus or to reflect the occurrence of unanticipated events.

Outsourcing Risks

As part of our restructuring program, we have outsourced substantially all of our manufacturing requirements. Outsourced manufacturing is carried out in three principal locations: Asia, Mexico and the United States. Outsourcing, particularly with international manufacturers, carries certain risks, which include, but may not be limited to:

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In addition, our outsourcing contractors acquire component parts from various suppliers. Similar risks are involved in such procurement efforts. Due to our dependency on outsourced manufacturing and the inherent difficulty in replacing outsourced manufacturing capacity in an efficient or expeditious manner, the occurrence of any condition preventing or hindering the manufacture or delivery of manufactured goods by any one or more of our outsourcing contractors would have a material adverse affect on our business in the short term and may have a material adverse affect in the long term. In 2002, we experienced significant problems associated with a principal outsource manufacturer. Faulty component parts used by the manufacturer in the production of a principal product caused a significant shortfall in product inventory, and led to our inability to meet product orders, negatively impacting sales and revenues. In addition, the Company was adversely affected by the port strike in early 2003 that resulted in the temporary closure of certain ports on the West Coast of the United States.

During the third quarter of 2002, the Company experienced difficulties in fulfilling certain product orders as a result of the production transition from Virginia to the outsourcing partners plus a backlog that has been built up with one of the United States outsourcing partners. These problems have been addressed by changing outsourcing partners. Also in 2002, we were forced to terminate our relationship with a principal outsource manufacturer and transition that work to other contractors. The terminated manufacturer was unable to meet substantially all of our product delivery orders because of financial and operational problems. That inability caused further problems for us in meeting customer orders and resulted in a substantial backlog, potential lost business and other losses. We filed an arbitration action against that manufacturer in 2002 in order to seek recovery of the losses caused by their failure in performance. While these problems with these contract manufacturers have been addressed, we cannot give assurances that they will not continue to have an impact on sales and revenues, or that similar or other significant problems will not occur in the future.

ITEM 2. PROPERTIES

The Company leases approximately 80,000 square feet of office and warehouse space in Sarasota, Florida, which serves as its corporate headquarters. This lease expires in January 2010.

The Company leases 26,000 square feet of light industrial space in Charlottesville, Virginia for use by its engineering and technical services functions. The building was previously owned by the Company, but was sold to a third party in 2001. The lease is on a month-to-month basis.

The Company leases 4,000 square feet of office space in Santa Clara, California for use by its engineering function. The lease is on a month-to-month basis.

ITEM 3. LEGAL PROCEEDINGS

Comdial currently and from time to time is involved in litigations arising in the ordinary course of its business. Those that the Company believes may have a significant impact on it are described below. Comdial can give no assurance that the resolution of any particular claim or proceeding would not have a material adverse effect on its results of operations, cash flows or financial condition.

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During February 2003, the Company discovered that approximately $0.6 million and $0.1 million of unauthorized disbursements were made from its pension plan during 2002 and 2003, respectively, by a former employee of Comdial. The full amount of these losses was reimbursed by the Company’s insurance carrier in October 2003.

On January 24, 2003, the Company was notified by letter from an insurance representative of the Catholic Cathedral of St. Thomas Moore that the Cathedral’s insurance carrier might pursue a subrogation claim based on a fire at the Cathedral that may have been caused by the installation or failure of equipment allegedly installed by the Company. The Company did not install any equipment at the Cathedral and has notified its insurance carrier of this claim. The Company believes that the repairs needed to repair the damage to the Cathedral were approximately $0.15 million, although it has received no written confirmation of same. There has been no further correspondence or other communication from any party in this matter. No amounts have been accrued in the Company’s financial statements for any losses.

During late 2002, the Company began discussions with a third party concerning a potential claim of patent infringement that such party has indicated it may bring against the Company. Although the Company expects to settle such claim prior to litigation, there can be no assurance that such settlement will be reached, or, even if settlement is reached, that the terms of such settlement will not have a material adverse affect on the Company. If settlement is not reached, and if litigation is filed against the Company, defense of such case will likely result in material expenditures and could have a material adverse affect on the Company. Further, there can be no assurance that the Company would prevail in such litigation, and a finding against the Company could reasonably be expected to have a material adverse affect on the Company. The Company has accrued its estimate of the probable settlement amount with respect to this matter, which is not material to the financial statements.

In suits filed against the Company and Allegheny Voice & Data, Inc. (“Allegheny”) in Kanawha County, West Virginia since November 2002, several former tenants of a commercial building, through their insurance carriers, allege that a telecommunications system sold by Comdial and installed by Allegheny caused a fire resulting in damage to the building. The total damages sought against Comdial and Allegheny by all claimants is approximately $1.1 million. After substantial investigation into this matter, the Company believes its equipment was not the cause of the fire, and has denied all of the substantive claims made against it in this matter. Motions are pending to consolidate these cases. No amounts have been accrued in the Company’s financial statements for any losses.

In November 2002, the Company filed a demand for arbitration with the American Arbitration Association against Boundless Manufacturing Services, Inc. (“Boundless”). Among other things, the Company contends that Boundless breached its contractual obligations to the Company by failing to meet the Company’s orders for the delivery of products manufactured by Boundless. The Company’s demand seeks damages in excess of $6.0 million. On February 6, 2003, Boundless responded to the Company’s demand by denying substantially all of the Company’s claims and asserting counterclaims totaling approximately $8.2 million, including approximately $0.8 million in past due invoiced amounts. The Company believes that Boundless’ claims are substantially without merit and that it has adequate substantive and procedural defenses against such claims. On March 13, 2003, Boundless announced that it has filed for protection pursuant to Ch. 11 of the U.S. Bankruptcy Code, causing a stay in the arbitration matter. It is not known at this time whether this filing will have any long-term impact on the arbitration, or whether the arbitration will eventually proceed. No amounts have been accrued in the Company’s financial statements for any losses.

On March 5, 2001, William Grover, formerly a senior vice president of Comdial, filed suit in state court in Charlottesville, Virginia alleging breach of an employment contract and defamation, and seeking compensatory, punitive and exemplary damages in the total amount of $1.9 million, plus interest. Among other things, Mr. Grover claimed that the for-cause termination of his employment was unjustified and that he is therefore entitled to all benefits accrued to him pursuant to the Company’s executive retirement plan. In pre-trial proceedings, the court dismissed all claims except for the tortious interference claim. On March 18, 2004, following a jury trial on that claim, the court granted Comdial’s motion to dismiss and the case was ended without jury deliberations. It is unknown at this time whether Mr. Grover will appeal. Comdial believes it has adequate substantive and procedural defenses against all claims made against Comdial in this matter and no amounts have been accrued in the Company’s financial statements for any losses.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Information is incorporated by reference from Comdial’s Schedule 14C definitive information statement dated October 27, 2003.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

As of March 19, 2004 there were 378 record holders of Comdial’s common stock.

Quarterly Common Stock Information

Beginning January 29, 2003, our common stock was listed on the Over the Counter Bulletin Board under the symbol CMDZ. From August 7, 2002 until January 29, 2003, our common stock was traded on the Pink Sheets Electronic Quotation System. Previously, our common stock was traded on the Nasdaq SmallCap Market, under the symbol CMDL, until the Company was delisted in the third quarter of 2002.

The following table sets forth, for the first two quarters of 2002 and each quarterly period in 2003, the high and low closing stock prices during the quarter in the over-the-counter market for Comdial’s Common Stock, as reported by the National Association of Security Dealers Automated Quotation System (“Nasdaq”). For the third and fourth quarters of 2002, the high and low stock prices are based on the bid quotations as reported by the Pink Sheets Electronic Quotation System. These quotations reflect inter-dealer prices without retail markup, markdown or commission and may not represent actual transactions.

Comdial has never paid a dividend on its common stock and its Board of Directors currently does not intend to change the policy of not paying cash dividends on common stock. In connection with the financings described in the Recent Developments section of Item 7 below, the Company is restricted from declaring or paying any dividends or distributions on its outstanding common stock.

Information regarding securities authorized for issuance under equity compensation plans is incorporated by reference under the caption “Securities Authorized for Issuance Under Equity Compensation Plans” of Comdial’s definitive proxy statement for the annual meeting of stockholders.

Recent Sales of Unregistered Securities.

Comdial has not sold any securities, registered or otherwise, within the past year, except as set forth below.

Soundpipe Acquisition

On June 6, 2003, Comdial Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of the Company, completed the acquisition of substantially all of the assets of Soundpipe Inc. (“Soundpipe”), a privately held Delaware corporation with its sole office in Santa Clara, California. Soundpipe was primarily engaged in the design and development of telecommunications equipment utilizing voice over Internet Protocol (VoIP) technology. The assets acquired include all of Soundpipe’s intellectual property, including, but not limited to equipment prototypes, software source code and several patent applications and trade secrets, and certain physical assets including computer equipment and office furnishings.

The acquisition involved the issuance of a total of 250,000 unregistered shares of the common stock of Comdial, par value $0.01 (the “Stock”). The Stock was issued as follows: 20,000 shares to Soundpipe; 180,000 shares to Altos Ventures, LLC (“Altos”), the principal shareholder of Soundpipe, as directed by Soundpipe on its behalf and in consideration of the cancellation of certain indebtedness held by Altos; and 50,000 shares to East Peak Advisors LLC.

The issuance described above is intended to be exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”), by virtue of the provisions of section 4(2) of the Securities Act.

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Options

The Company issued stock options to its employees and non-employee directors pursuant to its 2002 Employee and Non-Employee Director Stock Incentive Plan (the “2002 Empl/Non-Empl/Dir SO”) as follows:

There were no underwriters involved in connection with any transaction set forth above. Each of the issuances of securities described above was deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act and Regulation D promulgated there-under as a transaction not involving any public offering. In each of the above transactions, the recipients of securities represented their intention to acquire the securities for investment purposes only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were affixed to the securities issued.

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ITEM 6. SELECTED FINANCIAL DATA

FIVE YEAR FINANCIAL DATA

Selected Consolidated Statements of Operations Data For the Years Ended December 31:

In thousands, except per share amounts

The following discussion is intended to assist the reader in understanding and evaluating the financial condition and results of operations of the Company and its subsidiaries. This review should be read in conjunction with the consolidated financial statements and accompanying notes. This analysis attempts to identify trends and material changes that occurred during the periods presented.

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ITEM 7. MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS

Overview

During the past four years, Comdial’s annual net sales levels have decreased from the previous year’s activity. Primary causes for the decrease include, but are not limited to:

The decline in revenue from enterprise voice communications systems is attributable in part to the significant investments in these systems made by enterprises in the late 1990s in anticipation of Year 2000. We believe enterprises have been reluctant to make additional investments in voice communications systems until their existing investments have been fully amortized over their 7-10 year useful life. In addition, we believe many customers are hesitant to invest in traditional voice communications systems as they are anticipating the widespread adoption of next-generation communications systems, such as IP telephony systems.

Since the third quarter 2002 financial restructuring, the Company has focused a significant amount of management’s efforts at stabilizing the business, increasing market share, re-establishing its relationships with its wholesale distributors and dealer partners, focusing its product development efforts on IP-PBX related products, and improving gross margins and cash flow from operations.

The Key/hybrid voice switching market that Comdial has primarily operated in historically has declined in system line shipments since 2000. As reported by Phillips Infotech, the IP-PBX market that much of Comdial’s primary product development efforts are focused on, however, is expected to increase in system line shipments 35%, 23%, 25%, and 22% for the years 2004 through 2007, respectively. In the future, it will be important for Comdial to increase its market share in the IP-PBX market. Although its 2003 net sales were lower than the previous year, Comdial was able to generate positive cash flow from operating activities.

Critical Accounting Policies and Estimates

The consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States, which requires the use of estimates and assumptions (see Note 1 to the audited consolidated financial statements included elsewhere herein). Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

Revenue Recognition

We recognize revenue using the guidance from SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements”, Staff Accounting Bulletin No. 104, “Revenue Recognition, Corrected Copy”, and the AICPA Statement of Position No. 97-2, as amended, on “Software Revenue Recognition.” We allow certain of our customers to return unsold product when they meet Company-established criteria as outlined in the Company’s trade terms. Under these guidelines, we estimate the amount of product returns based upon actual historical return rates and any additional unique information and reduce our revenue by these estimated future returns. Returned products, which are recorded as inventories, are valued based upon expected realizability. If the historical data we use to calculate these estimates does not properly reflect future returns, these estimates could be revised.

Rebates and Incentives

We record estimated reductions to revenue for customer programs and incentive offerings including special pricing agreements, promotions, distributor price protection, and other volume-based incentives. If market conditions were to decline, we may take actions to increase rebates and incentive offerings possibly resulting in incremental reduction of revenue at the time the incentive is offered.

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Warranty

In most cases, we provide a two-year warranty to our customers, including repair or replacement of defective equipment. Our outsource manufacturing partners are responsible for the first year of the warranty repair work. We are using a third party contractor to perform much of this warranty. We provide for the estimated cost of product warranties at the time the revenue is recognized. We calculate our warranty liability based on historical product return rates and estimated average repair costs. While we engage in various product quality programs and processes, our warranty obligation may be affected by product failure rates, the ability of our outsource manufacturers to satisfy warranty claims and the cost of warranty repairs charged by the third party contractor. The outcome of these items could differ from our estimates and revisions to the warranty estimates could be required.

Allowance for Doubtful Accounts

We provide allowances for doubtful accounts for estimated losses from the inability of our customers to satisfy their accounts as originally contemplated at the time of sale. We calculate these allowances based on the detailed review of certain individual customer accounts, historical rates and our estimation of the overall economic conditions affecting our customer base. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventory

We measure our inventories at lower of cost or market. For those items that we manufacture, cost of sales is determined using standards that we believe approximates first-in, first-out (FIFO) method including material, labor and overhead. We also provide allowances for excess and obsolete inventory equal to the difference between the cost of our inventory and the estimated market value based upon assumptions about product life cycles, product demand and market conditions. If actual product life cycles, product demand, or market conditions are less favorable than those projected by management, additional inventory allowances or write-downs may be required.

Deferred Income Taxes

We estimate our actual current tax exposures together with our temporary differences resulting from differing treatment of items for accounting and tax purposes. These temporary differences result in deferred tax assets and liabilities. We then must assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent that we believe that recovery is not likely, based on the guidance in Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, we establish a valuation allowance. As of December 31, 2003 and 2002, all net deferred tax assets were reduced by a valuation allowance. In later years, after the Company ceases to have cumulative tax losses for three years, management will need to assess the continuing need for a full or partial valuation allowance. Significant judgment is required in this calculation and changes in this assessment could result in income tax benefits, in later periods, or the continued provision of valuation allowances until the realizability is more likely than not.

Due to the three-year cumulative basis losses, the Company recorded a valuation allowance equal to its net deferred tax assets of $41.5 and $41.9 million for the years ended December 31, 2003 and 2002, respectively. For the years ended December 31, 2003, 2002 and 2001, the Company recorded an increase (decrease) of its valuation allowance of $(0.4) million, $(0.5) million and $8.3 million, respectively. Approximately $3.1 million of the valuation allowance relates to tax benefits from a pension obligation that will be credited to other comprehensive income when realized.

At December 31, 2003, Comdial had net operating loss and credit carryovers of approximately $61.7 million and $1.4 million respectively, expiring beginning in 2004 through the year 2022. However, the Company experienced a change in control in 2002, pursuant to the provisions of IRC §382 and is subject to limitations on annual net operating loss deductions. As such, a significant portion of the net operating losses and tax credits are expected to expire prior to utilization.

Long-lived Assets, including Goodwill and Other Intangibles

In 2001 and prior, in accordance with Statement of Financial Accounting Standards No. 121, Impairment of Long-Lived Assets and Other Assets to Be Disposed of (“SFAS No. 121”), the Company reviewed long lived assets, including goodwill, for impairment whenever events or changes in circumstance indicated that the carrying amount of an asset might not be recoverable. If the review were to indicate that the carrying value of the long-lived assets were impaired, the carrying value was then reduced in accordance with SFAS No. 121.

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In October 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). SFAS No. 144 establishes a single accounting model, based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale, and resolves implementation issues related to SFAS No. 121. We adopted SFAS No. 144 effective January 1, 2002. For long-lived assets that are held for use, the Company compares the forecasted undiscounted net cash flows to the carrying amount. If the long-lived asset is determined to be unable to recover the carrying amount, then it is written down to fair value. A considerable amount of judgment is required in calculating this impairment charge, principally in determining financial forecasts. Unanticipated changes in market conditions could have a material impact on the Company’s projected cash flows. Differences in actual cash flows as compared to the projected cash flows could require us to record an impairment.

In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). SFAS No. 142 includes requirements to test goodwill and indefinite lived intangible assets for impairment rather than amortize them. Goodwill and other indefinite lived intangible assets must be tested for impairment on an annual basis, and any impairment charge resulting from the initial application of SFAS No. 142 is classified as a cumulative change in accounting principle. The Company adopted SFAS No. 142 and discontinued the amortization of goodwill effective January 1, 2002 and completed the transitional impairment test, determining that goodwill was not impaired. Impairment of goodwill is tested using a two step method. The first step is to compare the fair value of the reporting unit to its book value, including goodwill. Fair value is determined based on discounted cash flows, appraised values or management’s estimates, depending upon the nature of the assets. If the fair value of the unit is less than its book value, the Company then determines the implied fair value of goodwill by deducting the fair value of the reporting unit’s net assets from the fair value of the reporting unit. If the book value of goodwill is greater than its implied fair value, the Company writes down goodwill to its implied fair value. The Company’s goodwill relates to the messaging business segment. The Company performed its annual impairment review for 2003 and determined that no goodwill impairment charge needed to be recorded; however, there can be no assurances that subsequent reviews will not result in material impairment charges. A considerable amount of judgment is required in calculating this impairment charge, principally in determining discount rates, financial forecasts, and allocation methodology. Unanticipated changes in market conditions could have a material impact on the Company’s projected cash flows. Differences in actual cash flows as compared to the projected discounted cash flows could require us to record an impairment.

Retirement and Other Postretirement Benefit Plans

Prior to September 2000, we provided a defined pension benefit to our employees. In September 2000, we froze this plan. We accrue benefit obligations based on an independent actuarial valuation. This valuation has a number of variables, not only to estimate our benefit obligation, but also to provide us with minimum funding requirements for the retirement plan. The actuarial estimates include the expected rate of return on the retirement plan assets, the rate of compensation increases to eligible employees and the interest rate used to discount estimated future payments to retirement participants. During 2003, the Company’s discount rate used to estimate future payments to retirement participants decreased from 7.25% to 6.0%, reflecting an overall decrease in interest rates in the United States economy. For 2003, the Company’s discount rate of 6.0% approximated Moody’s Aa bond rate as of December 31, 2003. Differences in actual experience as compared to these estimates or future changes in these estimates could require us to make changes to these benefit accruals or recognize under funding in our pension plan.

On December 31, 2003 and 2002, the projected benefit obligations exceeded the market value of the plan assets (adjusted for accruals) by $8.4 million and $8.2 million, respectively. The amount recognized in other comprehensive loss during 2003 and 2002 arising from the increase in the additional minimum pension liability was $0.2 million and $8.2 million, respectively, net of tax benefits of $0 for both years. If the Company’s investment return and other actuarial assumptions remain unchanged, no contributions are projected to be required through 2004.

Commitments and Contingencies

Management’s current assessment of the claims that have been asserted against the Company is based on our review of the claim, our defenses and consultation with certain of our external legal counsel. Changes in this assessment could result as more information is obtained or as management decides that a settlement is more advantageous to the Company than a protracted legal process. These changes in our estimates of the outcome could require us to make changes in our conclusions or our accruals for these contingencies.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements included or incorporated by reference into our Securities and Exchange Commission filings, press releases, and shareholder communications and other information provided periodically in writing or orally by our officers, directors or agents, including this Form 10-K, are forward-looking statements that are subject to risks and uncertainties. These forward-looking statements are not historical facts but rather are based on certain expectations, estimates and projections about our industry, our beliefs and our assumptions. These risks could cause our actual results for 2004 and beyond to differ materially from those expressed, implied or forecasted in any forward-looking statement made by, or on behalf of, us. The risks and uncertainties include, but are not limited to, those discussed in “Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995” set forth in Part I above.

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Recent Developments

Soundpipe Acquisition

On June 6, 2003, Comdial Acquisition Corp. (“CAC”), a Delaware corporation and a wholly-owned subsidiary of Comdial, completed the acquisition of substantially all of the assets of Soundpipe Inc. (“Soundpipe”), a privately held Delaware corporation with its sole office in Santa Clara, California. Soundpipe was primarily engaged in the design and development of telecommunications equipment utilizing voice over Internet Protocol (VoIP) technology. The assets acquired include all of Soundpipe’s intellectual property, including, but not limited to equipment prototypes, software source code and several patent applications and trade secrets, and certain physical assets including computer equipment and office furnishings. The operations of CAC have been included in the accompanying statement of operations since the acquisition date.

The acquisition involved the issuance of a total of 250,000 unregistered shares of the common stock of Comdial, par value $0.01 (the “Stock”), the payment of $15,000 in cash to East Peak Advisors LLC, advisors to Soundpipe, the payment of $20,000 in legal fees incurred by Soundpipe in the transaction, and the assumption of certain specified operating liabilities.

CAC also extended offers of employment to eight then current or former employees of Soundpipe, and issued a total of 500,000 options to acquire the common stock of Comdial to these individuals. Included in these offers, CAC entered into one year employment agreements with the three principal founders of Soundpipe and issued a total of 330,000 of the aforementioned stock options pursuant to those employment agreements. In addition to the acquisition of the assets of Soundpipe, CAC also assumed certain executory contracts of Soundpipe, including certain software licenses and Soundpipe’s office lease.

Comdial accounted for the acquisition in accordance with Financial Accounting Standards Board Statement No. 141, Business Combinations (“Statement 141”). The acquisition was measured on the basis of the fair values exchanged. The Company acquired current assets with an estimated fair value of $12,900 and property and equipment with an estimated fair value of $61,000. Comdial assumed certain operating liabilities with an estimated fair value of $120,000 and issued 250,000 shares of common stock which were valued at the closing stock price on June 6, 2003 of $2.00 per share, for a fair value of $500,000. To determine the fair value of the acquired technology, Comdial measured the projected discounted net cash flows for the next two years and estimated that the fair market value of the technology significantly exceeded the cost of the acquisition. In accordance with Statement 141, since the total fair value of assets acquired and liabilities assumed exceeded the total cost of the acquisition (the “excess”), the excess was reduced from the fair value assigned to the purchased technology. Consequently, the amount assigned to the acquired technology was $546,000 and is reported in capitalized software development costs in the accompanying consolidated balance sheet. These costs will be amortized over a three year life.

Prior to the Soundpipe acquisition, Comdial had two development projects that had reached technological feasibility and software development costs were being capitalized. As a result of the Soundpipe acquisition, management reviewed all current development projects in process and, in order to maximize benefits from development funds expended, placed emphasis on the Soundpipe technology acquired. Therefore, management decided to discontinue these two historical Comdial development projects. The software that had been developed is not expected to be used in any future product development and will not generate any future cash flows. As a result, the amounts that had been capitalized related to those two projects of $365,000 were written off in June 2003 and are recorded as impairments of long-lived assets in the consolidated income statement.

2004 Bridge Financing

During 2003 and 2004, the Company initiated a plan to investigate the opportunities to raise additional cash funding for the business. These funds would be used to expand the sales and marketing efforts in the IP-PBX market, augment the Company’s product development efforts and to provide additional working capital to support operations in a very competitive environment.

On March 12, 2004, the Company closed a bridge financing transaction involving the private placement of 90 units at a price of $0.1 million per unit resulting in gross proceeds to the Company of $9.0 million (the “ 2004 Bridge Financing”). Each unit includes a warrant to purchase 20,000 shares of the Company’s voting common stock at an exercise price of $3.38 per share until February 17, 2007 (the “2004 Bridge Warrants”) and a $0.1 million subordinated convertible note which includes interest payable quarterly at the annual rate of 8% (the “2004 Bridge Notes”). Commonwealth Associates, L.P. (“Commonwealth”) served as placement agent for the 2004 Bridge Financing in exchange for the payment of certain of its expenses and a cash fee equal to 7.5% of the gross proceeds of the transaction.

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The 2004 Bridge Notes are subordinate to the senior subordinated secured convertible notes that were issued by the Company pursuant to the private placement the Company consummated in 2002 for a total of $13.3 million (the “Placement Notes”) and the private placement the Company consummated with Winfield Capital Corp. of $2.0 million in 2002 (the “Winfield Transaction”) and to any senior credit facility or other secured obligations the Company enters into with a bank, insurance company, finance company or other institutional lender. The 2004 Bridge Notes are convertible as follows: (a) The 2004 Bridge Notes will automatically convert into the same class of securities that the Company issues pursuant to any financing occurring on or before May 14, 2004 which raises at least $4 million in gross proceeds or results in the conversion of at least 50% of the Placement Notes pursuant to an amendment to those notes, as described below (hereafter, a “Subsequent Financing”); (b) If no Subsequent Financing occurs on or before May 14, 2004, the holders of the 2004 Bridge Notes will have the right to convert the 2004 Bridge Notes into common stock at the conversion price of $2.50 per share at any time prior to the maturity of the notes, in whole or in part; and (c) The Company may convert the 2004 Bridge Notes into common stock at $2.50 per share if (i) the average closing price of the common stock equals or exceeds $5.00 per share for 20 consecutive trading days, (ii) the average daily trading volume during such 20 days is at least 50,000 shares, (iii) the common stock is then trading on a national stock exchange such as the Nasdaq National Market or the Nasdaq SmallCap Market, (iv) the shares into which the Bridge Notes would be converted are registered with the SEC or are exempt from registration pursuant to SEC Rule 144(k), and (v) the shares are not subject to any contractual restrictions on trading, such as a lock-up agreement with an underwriter. The 2004 Bridge Notes mature on the earlier of September 27, 2005 or the occurrence of certain events.

The 2004 Bridge Warrants are exercisable by the holder for three years from date of issuance at an exercise price of $3.38 per share, either by paying such amount in cash to the Company or on a cashless exchange basis. The Company can redeem the 2004 Bridge Warrants by paying the holder $0.01 per share upon five business days notice, if: (a) the closing price of the Common Stock is at least $6.76 for 20 consecutive trading days; (b) the Common Stock is trading on the Nasdaq Small Cap, Nasdaq National Market or another national securities exchange; (c) the average daily trading volume during such 20 day period equals or exceeds 50,000 shares; and (d) the shares issuable upon exercise of the 2004 Bridge Warrants are covered under an effective registration statement or are otherwise exempt from registration.

In connection with the 2004 Bridge Financing, the Company entered into an amendment to the Placement Notes that extends the maturity of the notes by one year to September 27, 2006, and gives the holders conversion rights. Such conversion shall be at a conversion price of $5.00 per share exercisable at any time prior to maturity; except that, the conversion price shall be $3.38 for a period commencing 20 calendar days after the filing of an Information Statement pursuant to Regulation 14C of the Securities Exchange Act of 1934 and ending on the later of (i) March 31, 2004, or (ii) five business days after shareholder approval of the 2004 Bridge Financing becomes effective in accordance with Regulation 14C. In addition, the Placement Notes may in the future be convertible under certain circumstances at the option of the Company if the common stock of the Company trades at or above $10.00 for 20 consecutive trading days. The initial conversion price of the Placement Notes is $4.95 per share. The conversion price of the Placement Notes is subject to downward adjustment in the event of certain defaults. The amendment also grants certain registration rights to the holders of the Placement Notes. The amendment to extend the maturity date and provide additional conversion rights does not apply to the 2002 Winfield Transaction.

Chief Executive Officer Resignation

In March 2004, Nickolas A. Branica resigned and the Company announced that Neil P. Lichtman, Comdial’s president, will succeed Mr. Branica as chief executive officer. Pursuant to Mr. Branica’s employment agreement as amended, he will receive as severance an amount equal to twelve months of his annual base salary at the rate in effect on the date his employment terminated. In addition, all of Mr. Branica’s stock options were immediately vested. Mr. Branica will receive medical, life and other insurance benefits for a period of up to twelve months following his employment termination.

2004 Restructuring

In connection with the Company’s continued focus on improving cash flow from operations, the Company initiated a restructuring plan (the “Plan”) during the first quarter of 2004. Pursuant to the Plan, approximately 20 employees were notified as of March 15, 2004 that their positions would be eliminated during the following eight weeks. The Company anticipates paying approximately $0.1 million in severance and related benefits during the second quarter of 2004 related to the Plan.

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SEGMENT REPORTING

RESULTS OF OPERATIONS

Selected consolidated statements of operations for the last three years are as follows:

The following table reflects the gross profit margins for the various business segments of Comdial. See Note 14 to the Consolidated Financial Statements for further clarification of business segments.

The following table sets forth the percentage of revenues represented by certain items reflected in our statements of operations:

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During 2003, a significant emphasis was placed on stabilizing the business and improving gross margins and cash flow from operations. Improvements were made through focusing the Company’s sales efforts at higher margin product lines, cost reduction projects with the Company’s outsourced manufacturers and higher levels of automation, both for internal processes within the Company and external processes with its partners and vendors.

2003 COMPARED TO 2002

Net sales for 2003 decreased by 7% to $47.9 million, compared with $51.7 million in 2002. The primary factor in the decrease of sales was the overall market contraction.

Gross profit decreased by 4% in 2003 to $16.5 million, compared with $17.2 million in 2002, primarily due to the decrease in net sales described above. Gross profit, as a percentage of sales, increased from 33% in 2002 to 34% for 2003. This increase is primarily due to a change in product mix, as the Company sold more higher margin products in 2003.

Comdial records provisions related to product obsolescence of its products, which are charged against gross profit. For the years 2003 and 2002, provisions for obsolescence totaled $1.8 million and $0.9 million, respectively. The provision for obsolescence and valuation for 2003 was higher primarily due to the lower than anticipated demand for discontinued and refurbished products which the Company had expected to sell during 2003. Future reserves will be dependent on management’s estimates of the recoverability of inventory costs and shifts in product demands.

Comdial records accruals related to potential warranty claims that may result from product warranty, which are charged against gross profit. In most cases, we provide a two-year warranty to our customers, including repair or replacement of defective equipment. We use a third party contractor to perform much of this warranty. Our outsource manufacturing partners are responsible for the first year of the warranty repair work. We provide for the estimated cost of product warranties at the time the revenue is recognized. In 2003, we decreased the warranty accrual by $0.2 million due to several factors, including a reduction in product repair return rates and a reduction in the price charged by the third party contractor that performs much of the warranty repair work. While we engage in various product quality programs and processes, our warranty obligation may be affected by product failure rates, the ability of our outsource manufacturers to satisfy warranty claims and the cost of warranty repairs charged by the third party contractor. The outcome of these items could differ from our estimates and revisions to the warranty estimates could be required.

Selling, general and administrative expenses (“SG&A”) decreased in 2003 by 25% to $15.5 million compared with $20.6 million for 2002. This decrease primarily resulted from downsizing the work force and more closely controlling costs. In addition, Comdial recorded bad debt expense in 2002 of $0.4 million compared with ($0.1) million in 2003. SG&A expenses, as a percentage of sales for 2003, decreased to 32% compared with 40% for 2002.

Engineering, research and development expenses decreased in 2003 by 34% to $3.5 million compared with $5.3 million for 2002, primarily due to the downsizing of the work force and lower amortization of software development costs. Engineering expenses, as a percentage of sales for 2003, decreased to 7% compared with 10% for 2002.

In connection with the Bridge Financing in 2002 (see Note 2 to the consolidated financial statements included herein), warrants to purchase 100,000 shares of common stock were issued to two executive officers of the Company. The warrants are exercisable at $0.15 per share until June 21, 2007. Compensation expense of $0.5 million was recorded based on the intrinsic value of the warrants on the grant date. In addition, Commonwealth received 16,667 shares of the Company’s common stock upon signing of the Advisory Agreement on June 7, 2002. Expense of $0.1 million was recorded based on the stock price on that date. Previously, directors could elect to defer receipt of their performance based stock options; however, in 2002, the Company settled all unearned amounts due to former directors with agreed upon cash payments and recognized income of $0.1 million related thereto. There were no significant stock based compensation awards in 2003.

Impairments of Long-Lived Assets - In accordance with SFAS No. 144, the Company evaluates long-lived assets for impairment whenever events or changes in circumstance indicate that the carrying amount of an asset may not be recoverable. In 2003, prior to the Soundpipe Acquisition described above in Recent Developments, Comdial had two development projects that had reached technological feasibility and software development costs were being capitalized. As a result of the Soundpipe acquisition, management reviewed all current development projects in process and, in order to maximize benefits from development funds expended, placed emphasis on the Soundpipe technology acquired. Therefore, management decided to discontinue these two historical Comdial development projects. The software that had been developed is not expected to be used in any future product development and will not generate any future cash flows. As a result, the amounts that had been capitalized related to those two projects of $365,000 were written off in 2003 and are recorded as impairments of long-lived assets in the consolidated income statement. In 2002, as a result of the outsourcing of the manufacturing operations, the majority of the manufacturing assets were sold or otherwise disposed of. The Company’s projected undiscounted cash flows related to those assets were less than the net book value of the assets associated with the business. Such analysis resulted in impairment loss of fixed assets in the amount of $0.2 million for 2002. As part of Comdial’s decision to outsource manufacturing and reduce the number of product lines to a more appropriate level in 2002, certain capitalized software development costs were impaired. Capitalized software development costs relating to product lines that were to be discontinued were considered impaired due to the Company’s inability to realize any future benefit from these assets. The impairment loss of capitalized software amounted to $0.7 million in 2002.

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Interest expense decreased in 2003 by 58% to $3.3 million compared with $7.8 million in 2002. This was primarily due to the accretion of the discount on the Bridge Notes (see Note 2) during 2002.

During 2002, Comdial restructured its senior debt with Bank of America and recorded a gain of $14.9 million (see Note 2 to consolidated financial statements). In addition, the Company restructured liabilities with certain other vendors and creditors, including terminating the Retirement Benefit Restoration Plan and other postretirement benefits; the Company recorded a gain of $3.8 million on these restructurings. The Company also renegotiated its leases with Relational Funding Corporation and its assignees and recorded a gain of $2.8 million. See Note 3 to consolidated financial statements for additional description on these restructurings and related gains. The Company also recognized a previously deferred gain on the sale of Array assets to ePHONE of $1.3 million and a gain of $1.6 million on a settlement with ePHONE (see Note 4 to consolidated financial statements) resulting from an arbitration award.

Income before income taxes, as a result of the foregoing, was a loss of $6.1 million in 2003 as compared with income of $6.5 million before income taxes in 2002. The major factor contributing to the income in 2002 is the debt restructurings discussed above. Major factors contributing to the loss for 2003 include the decrease in sales and other factors such as increased inventory write-offs due to the lower than anticipated demand for discontinued and refurbished products.

The Company did not generate taxable income during 2003 or 2002 and, therefore, did not record any income tax expense for those periods. The Company has provided a full valuation allowance on its net deferred tax assets, consisting primarily of net operating loss carryforwards, because of uncertainty regarding its realizability (see Note 9 to the Consolidated Financial Statements).

2002 COMPARED TO 2001

Net sales as reported for 2002 decreased by 32% to $51.7 million, compared with $76.2 million in 2001. The primary factors in the decrease of sales were the overall market contraction and the elimination of the Company’s Avalon product line that targeted the assisted living market. In 2002, the Company experienced difficulties in fulfilling certain product orders as a result of the production transition from its own manufacturing in Virginia to the outsourcing partners plus a backlog that had been built up with one of the United States outsourcing partners. These problems were addressed by changing outsourcing partners. Also in 2002, one principal outsource manufacturer was unable to meet substantially all of our product delivery orders because of financial and operational problems. That inability caused further problems for us in meeting customer orders and resulted in a substantial backlog, potential lost business and other losses. As a result, we were forced to terminate our relationship with that manufacturer and transition that work to other contractors. We filed an arbitration action against that manufacturer in 2002 in order to seek recovery of the losses caused by their failure in performance; this action is still pending.

Gross profit decreased by 28% in 2002 to $17.2 million, compared with $23.8 million in 2001, primarily due to the decrease in net sales described above. Gross profit, as a percentage of sales, increased from 31% in 2001 to 33% for 2002. This increase was primarily due to the Company fully outsourcing manufacturing during 2002, which lowered costs. In addition, the product obsolescence provisions described below had a higher negative impact in 2001 than in 2002.

Comdial records provisions related to product obsolescence of its products, which are charged against gross profit. For the years 2002 and 2001, provisions for obsolescence totaled $0.9 million and $2.5 million, respectively. The provision for obsolescence and valuation for 2001 was higher primarily due to increased product discontinuance. Another factor that caused the inventory obsolescence provision to be higher in 2001 was the decision to completely outsource manufacturing, which rendered some raw materials and components obsolete. Future reserves are dependent on management’s estimates of the recoverability of inventory costs and shifts in product demands.

Comdial records accruals related to potential warranty claims that may result from product warranty, which are charged against gross profit. In most cases, we provide a two-year warranty to our customers, including repair or replacement of defective equipment. As of 2002, we were using a third party contractor to perform much of this warranty. We provide for the estimated cost of product warranties at the time the revenue is recognized. In 2002, we increased the warranty accrual by $0.2 million. While we engage in various product quality programs and processes, our warranty obligation may be affected by product failure rates, the ability of our outsource manufacturers to satisfy warranty claims and the cost of warranty repairs charged by the third party contractor. The outcome of these items could differ from our estimates and revisions to the warranty estimates could be required.

Comdial charged $0.5 million to cost of sales resulting from physical inventory discrepancies in 2002 compared with $0.4 million of such charges in 2001.

Selling, general and administrative expenses (“SG&A”) decreased in 2002 by 31% to $20.6 million compared with $30.0 million for 2001. This decrease primarily resulted from downsizing the work force and more closely controlling costs. In addition, Comdial recorded bad debt expense in 2001 of $2.3 million compared with $0.4 million in 2002. SG&A expenses, as a percentage of sales for 2002, increased to 40% compared with 39% for 2001. This increase primarily resulted from the decrease in net sales described above.

Engineering, research and development expenses decreased in 2002 by 30% to $5.3 million compared with $7.6 million for 2001, primarily due to the downsizing of the work force. Engineering expenses, as a percentage of sales for 2002, remained similar to 2001 at 10%.

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In connection with the Bridge Financing in 2002 (see Note 2), warrants to purchase 100,000 shares of common stock were issued to two executive officers of the Company. The warrants are exercisable at $0.15 per share until June 21, 2007. Compensation expense of $0.5 million was recorded based on the intrinsic value of the warrants on the grant date. In addition, Commonwealth received 16,667 shares of the Company’s common stock upon signing of the Advisory Agreement on June 7, 2002. Expense of $0.1 million was recorded based on the stock price on that date. Previously, directors could elect to defer receipt of their performance based stock options; however, in 2002, the Company settled all unearned amounts due to former directors with agreed upon cash payments and recognized income of $0.1 million related thereto. There were no stock based compensation awards in 2001.

Restructuring – There were no new restructuring plans implemented in 2002.

Impairments of Long-Lived Assets - In accordance with SFAS No. 144 in 2002 and SFAS No. 121 in 2001, the Company evaluated long-lived assets for impairment whenever events or changes in circumstance indicate that the carrying amount of an asset may not be recoverable. In light of the restructuring and the initiative to outsource manufacturing, the Company identified certain of its fixed assets related to its manufacturing operations, purchased software, capitalized software development costs, and the goodwill related to its purchase of Array as assets that were impaired. This was based on an analysis of discounted and undiscounted (as applicable) cash flows that were no longer deemed adequate to support the value of the assets associated with the business. The impairments, included in Impairments of Long-Lived Assets on the consolidated income statement are discussed below:

Property and Equipment Impairment - As a result of the outsourcing of the manufacturing operations, the majority of the manufacturing assets were sold or otherwise disposed of in 2002. The Company’s projected undiscounted cash flows related to those assets were less than the net book value of the assets associated with the business. Such analysis resulted in impairment loss of fixed assets in the amount of $0.2 million for 2002 and $1.0 million for 2001.

Capitalized Software Impairment - As part of Comdial’s decision to outsource manufacturing and reduce the number of product lines to a more appropriate level, certain capitalized software development costs were impaired. Capitalized software development costs relating to product lines that were discontinued were considered impaired due to the Company’s inability to realize any future benefit from these assets. The impairment loss of capitalized software amounted to $0.7 million in 2002 and $1.4 million in 2001.

Goodwill Impairment - Comdial sold the majority of the assets of Array Telecom Corp. to ePHONE Telecom, Inc. and simultaneously entered into a licensing agreement with ePHONE on March 31, 2000. In October 2001, ePHONE filed for arbitration against the Company alleging fraud in the inducement, among other things, and seeking return of the $2.7 million paid to Comdial plus additional compensatory and punitive damages. The Company filed counterclaims against ePHONE, claiming that ePHONE had not paid the minimum royalties due under the license agreement. Additionally, Comdial was seeking $1.9 million in lost revenue based on the termination of the license agreement brought about by ePHONE’s breach. While the arbitration proceeding was pending, Comdial concluded the remaining goodwill was impaired and recognized a loss of $0.8 million in 2001.

Interest expense increased in 2002 by 183% to $7.8 million compared with $2.8 million in 2001. This was primarily due to the amortization of the deferred financing costs and the accretion of the discount on the Bridge Notes (see Note 2), offset by lower levels of debt during most of 2002 due primarily to the March 2002 restructuring with Bank of America (see Note 3).

During 2002, Comdial restructured its senior debt with Bank of America and recorded a gain of $14.9 million (see Note 2 to consolidated financial statements). In addition, the Company restructured liabilities with certain other vendors and creditors, including terminating the Retirement Benefit Restoration Plan and other postretirement benefits; the Company recorded a gain of $3.8 million on these restructurings. The Company also renegotiated its leases with Relational Funding Corporation and its assignees and recorded a gain of $2.8 million. See Note 3 to consolidated financial statements for additional description on these restructurings and related gains. The Company also recognized a previously deferred gain on the sale of Array assets to ePHONE of $1.3 million and a gain of $1.6 million on a settlement with ePHONE (see Note 4 to consolidated financial statements) resulting from an arbitration award.

Income before income taxes, as a result of the foregoing, amounted to $6.5 million in 2002 as compared with a loss of $21.2 million before income taxes in 2001. The major factor contributing to the income in 2002 is the debt restructurings discussed above. Major factors contributing to the loss for 2001 include restructuring and asset impairments, and other factors such as increased bad debt reserves and inventory write-offs due to product discontinuance.

The Company did not generate taxable income during 2002 or 2001 and, therefore, did not record any income tax expense for those periods. The Company has provided a full valuation allowance on its deferred tax asset, consisting primarily of net operating loss carryforwards, because of uncertainty regarding its realizability (see Note 9 to the Consolidated Financial Statements).

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LIQUIDITY AND CAPITAL RESOURCES

Historically, the Company’s liquidity and capital resources have been highly dependent on cash funding from external sources of interest-bearing capital. Until the Company’s operations generate sufficient positive cash flow from operations to cover capital expenditures and debt service, the Company will be required either to convert interest-bearing debt securities to equity securities or to raise additional cash through additional debt or equity-based capital transactions. Improvements in cash flow from operations will be based, to a large extent, on moving the Company further into the IP-PBX market, on improving gross margins for the IP-PBX products and on minimizing the overhead costs associated with its operations. The expansion of the Company’s IP-PBX net sales activity will be based on the recently introduced CONVERSip^TM product lines.

The following table sets forth Comdial’s cash and cash equivalents, current maturities on debt, and working capital at the dates indicated:

The Company’s net sales and working capital can be impacted by the extent of product inventories carried by the Company’s wholesale distribution partners at a given point in time. Fluctuations of these inventory levels can have a dramatic impact on the Company’s cash position.

In late 2002, majority control of the Company’s stock ownership changed. Since then, changes have been made in the management team and in operations in efforts to increase sales, improve gross margins and further control other expenses so that the Company can achieve profitability. In December 2003, management obtained a letter of intent for a $2.5 million asset-backed credit facility, which it intends to pursue further, although there are no assurances that this financing will be executed. In addition, in March 2004, the Company closed a bridge financing transaction resulting in gross proceeds to the Company of $9.0 million. The accompanying financial statements have been prepared on the going concern basis. Management believes that its cash flow from the additional financing and from operations, combined with cash and working capital on hand, will be sufficient to allow the Company to meet its operating expenses, debt service and capital expenditure requirements for at least the next year. However, if sales levels and/or gross margins decline, other operating expenses increase, or other matters arise, management could be required to reassess the recoverability of its assets and possibly record impairment charges or other asset valuation charges, undertake an alternative plan to potentially include further restructuring or changes in the business, or seek additional debt or equity financing.

In connection with the debt restructuring in 2002, ComVest deposited $1.5 million to secure two outstanding letters of credit previously issued by Bank of America to the Company, and entered into the Pledge Agreement with Bank of America concerning the disposition of the deposited funds. As security for the deposit, the Company entered into the Reimbursement Agreement with ComVest, and issued the Revolving Note to ComVest in the amount of the deposit. On October 25, 2002, ComVest and the Company entered into the Amendment to the Reimbursement Agreement, pursuant to which the Company paid $1.5 million to ComVest and ComVest issued a letter of direction to Bank of America directing Bank of America to pay to the Company any amounts payable to ComVest pursuant to the Pledge Agreement. In addition, the Revolving Note was canceled. As of December 31, 2002, the $1.5 million remained on deposit with Bank of America as collateral for the two letters of credit, and was recorded in prepaid expenses and other current assets in the accompanying balance sheet. In March 2003, the letters of credit expired and BofA paid, under the terms of the letter of direction discussed above, $1.5 million to the Company. In April 2003, the Company obtained two new letters of credit totaling $1.0 million and was required to secure these letters of credit with $1.0 million of cash, which the Company recorded as restricted cash in the accompany consolidated balance sheet as of December 31, 2003.

As of December 31, 2003, the Company’s cash and cash equivalents were lower than December 31, 2002 by $0.2 million and working capital declined by $1.8 million due primarily to use of the proceeds from the private placement financing (see Note 2 to the consolidated financial statements included herein) to fund operations during 2003.

Accounts Receivable at December 31, 2003, decreased by $4.5 million compared with December 31, 2002, primarily due to the decreased level of sales during the year, as well as improved collections. The allowance for doubtful accounts on trade receivables was $0.3 million on gross trade receivables of $4.1 million at December 31, 2003. This allowance is used to state trade receivables at a net realizable value or the amount that the Company estimates will be collected on gross receivables as of December 31, 2003.

Inventory at December 31, 2003 decreased by $1.1 million compared with December 31, 2002, due primarily to additional reserves for discontinued product lines and obsolescence of $1.2 million.

Deferred financing costs at December 31, 2003, decreased by $2.0 million due primarily to amortization of the costs incurred in 2002.

Capitalized software development costs decreased by $0.1 million primarily due to current year amortization of capitalized assets and the write-off of $0.4 million of capitalized software development, offset by current year capitalized software additions of $2.1 million. Comdial currently has a number of new products and product enhancements at various phases. As of December 31, 2003, the Company has approximately $2.7 million of capitalized software development costs related to its new CONVERSip^TM product lines, which are scheduled for release during 2004.

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Cash expenditures for capital additions for 2003, 2002 and 2001 amounted to $0.3 million, $0.04 million and $0.3 million, respectively. Management anticipates that approximately $0.5 million will be spent on capital additions and $2.2 million will be spent on software development activities during 2004 which are expected to be funded by cash generated from operations.

Accounts payable at December 31, 2003, decreased by $3.5 million when compared to December 31, 2002. This decrease was primarily due to using proceeds from the bridge financing in 2002 (see Note 2) and operations to pay vendors.

CONTRACTUAL OBLIGATIONS

The following table sets forth the contractual obligations of the Company as of December 31, 2003:

In connection with the 2004 Bridge Financing (see Note 21 to the consolidated financial statements), the Company entered into an amendment to the Placement Notes that extends the maturity of the notes by one year to September 27, 2006, and gives the holders conversion rights. Such conversion shall be at a conversion price of $5.00 per share exercisable at any time prior to maturity; except that, the conversion price shall be $3.38 for a period commencing 20 calendar days after the filing of an Information Statement pursuant to Regulation 14C of the Securities Exchange Act of 1934 and ending on the later of (i) March 31, 2004, or (ii) five business days after shareholder approval of the 2004 Bridge Financing becomes effective in accordance with Regulation 14C. In addition, the Placement Notes may in the future be convertible under certain circumstances at the option of the Company if the common stock of the Company trades at or above $10.00 for 20 consecutive trading days. The initial conversion price of the Placement Notes is $4.95 per share. The conversion price of the Placement Notes is subject to downward adjustment in the event of certain defaults. The amendment also grants certain registration rights to the holders of the Placement Notes. The amendment to extend the maturity date and provide additional conversion rights does not apply to the 2002 Winfield Transaction. The principal amount of the Placement Notes is payable on the maturity date. Interest is payable quarterly in arrears. The Placement Notes are secured by a second lien (subordinated to the first lien of Winfield Capital Corp. described below) on substantially all of the Company’s assets. While the note is outstanding, the Company is restricted from declaring or paying any dividends or distributions on its outstanding common stock.

Also on September 27, 2002, the Company consummated a private placement with Winfield Capital Corp. of $2.0 million (the “Winfield Transaction”). The Winfield Transaction consisted of 12% subordinated secured convertible promissory notes (the “Winfield Notes”) and warrants to purchase 0.4 million shares of common stock at an exercise price of $0.15 per share (the “Winfield Warrants”) at any time through September 27, 2004. The Winfield Notes are due on September 27, 2005 and provide for quarterly interest- only payments with the entire principal due upon maturity. The Winfield Warrants, which were valued at $0.3 million using the Black Scholes method, were recorded as deferred financing costs. The Winfield Notes may in the future be convertible under certain circumstances at the option of the Company if the common stock of the Company trades at or above $15.00 for 20 consecutive trading days. The initial conversion price of the Winfield Notes is $4.95 per share. The conversion price of the Winfield Notes is subject to downward adjustment in the event of certain defaults. The Winfield Notes are senior in right of payment and security to the Placement Notes.

The contractual payment obligations for both principal and interest are included in the above schedule.

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During 2002, the Company reached separate agreements (the “Agreements”) with the three former executives of the Company who still had vested benefits under the Retirement Benefit Restoration Plan (see Note 11). The Agreements provide for aggregate monthly payments of $3,750 beginning in May 2002 and continuing for 36 months for a total of $0.1 million, with the remaining aggregate balance of $0.4 million to be paid in a lump sum in June 2005, for a total aggregate payout of $0.5 million.

RELATED PARTY TRANSACTIONS

As a part of the September 27, 2002 Private Placement, Commonwealth Associates L.P. (“Commonwealth”), as Placement Agent for the private placement, received advisory fees of $60,000 and $35,000 in 2003 and 2002, respectively. See Note 2.

During 2002, ComVest Venture Partners, L.P. (“ComVest”) deposited $1.5 million to temporarily secure two outstanding letters of credit previously issued by Bank of America to the Company. Commonwealth was paid a fee of $30,000 for its services in arranging the deposit by ComVest. See Note 8.

The Company entered into an employment agreement with Travis Lee Provow in November 2002, whereby Mr. Provow agreed to serve as the Company’s Chairman of the Executive Committee (an officer position) beginning on November 25, 2002. The term of Mr. Provow’s employment was for six months and was renewable for a further six months upon the mutual agreement of both the Company and Mr. Provow. Pursuant to the terms of the employment agreement, Mr. Provow was to be paid at the rate of $180,000 per year and was issued options to purchase 166,667 shares of common stock at the exercise price of $1.80 per share. The options were issued outside of the Company’s existing stock option plan and become exercisable 40% at date of grant and increments of 20% as of each anniversary of Mr. Provow’s employment with the Company, provided that Mr. Provow remained an employee or director of the Company. Mr. Provow also served as President and Managing Director of Commonwealth Holdings, LLC. In August 2003, Mr. Provow resigned his position as chairman of the Company’s Executive Committee but agreed to remain on the Board as a director. The stock option agreement was amended to reduce the number of options by 50,000. In connection with the modification of Mr. Provow’s stock option agreement, the Company recorded stock compensation expense of approximately $26,000 for the year ended December 31, 2003.

During 2002, the Company issued 2.9 million warrants to Commonwealth, ComVest, Shea Ventures, LLC, or Company officers, all of which are related parties, to purchase shares of the Company’s common stock at an exercise price of $0.15 per share. As of December 31, 2003, 0.5 million of such warrants were outstanding. See Notes 2, 3, 8 and 21 for additional related party disclosures.

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OTHER FINANCIAL INFORMATION

During fiscal years 2003, 2002 and 2001, primarily all of Comdial’s sales, net income, and identifiable net assets were attributable to the telecommunications industry.

During February 2003, the Company discovered that approximately $0.6 million and $0.1 million of unauthorized disbursements were made from its pension plan during 2002 and 2003, respectively, by a former employee of Comdial. The full amount of these losses was reimbursed by the Company’s insurance carrier in October 2003.

NASDAQ DELISTING

The Company’s common stock was delisted from the Nasdaq SmallCap Market on August 7, 2002. The Company received a letter from Nasdaq on August 6, 2002 stating that the decision to delist the Company’s stock was made principally due to the Company’s failure to obtain either shareholder approval prior to closing of the bridge financing transaction entered into in June 2002 (see Note 2) or permission from Nasdaq to proceed with the transaction in the absence of such approval. The Bridge Financing resulted in the issuance of promissory notes to ComVest and Mr. Branica that converted into common stock substantially in excess of the threshold ownership levels permitted without shareholder approval under the applicable NASDAQ rules. Beginning January 29, 2003, the Company’s common stock began to be quoted on the NASD’s OTC-BB.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Comdial believes that it does not have any material exposure to market risk associated with interest rate risk, foreign currency exchange rate risk, commodity price risk, equity price risk, or other market risks.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Stockholders and Board of Directors of Comdial Corporation:

We have audited the accompanying consolidated balance sheets of Comdial Corporation (“the Company”) as of December 31, 2003 and 2002 and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about 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, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Comdial Corporation at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related 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.

As discussed in Notes 1 and 18 to the consolidated financial statements, effective January 1, 2002, the Company adopted Statement of Financial Standards No. 142, “Goodwill and Other Assets,” which resulted in the cessation of the amortization of goodwill.

/s/ Ernst & Young LLP

Tampa, Florida

March 15, 2004

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Consolidated Balance Sheets

The accompanying notes are an integral part of these financial statements.

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Consolidated Statements of Operations