<PAGE>

                                                                    Exhibit 10.7

                     SETTLEMENT AGREEMENT AND MUTUAL RELEASE

           THIS SETTLEMENT AGREEMENT AND MUTUAL RELEASE (this "Agreement") is
entered into effective as of August 1, 2002 by and among Telenetics Corporation,
a California corporation ("Telenetics"), on the one hand, and John D. McLean, an
individual ("McLean"), William C. Saunders, an individual ("Saunders"), Terry S.
Parker, an individual ("Parker") and Saunders & Parker, Inc., a Texas
corporation ("S&P", and together with McLean, Saunders and Parker, the
"Defendants"), on the other. This Agreement is entered into with reference to
the following facts:

                                 R E C I T A L S
                                 ---------------

           A. On or about October 19, 2001, Telenetics filed a Complaint against
Defendants and Edward L. Didion, an individual ("Didion") in the United States
District Court, Central District of California, Southern Division (Case No.
SA01-987-AHS (ANX)) (the "Action").

           B. Defendants and Telenetics wish to settle all differences between
them which arise out of or which in any way are connected with or related to any
of the claims, allegations, causes of action and/or contentions set forth in the
Action.

           C. In contemplation of entering into this Agreement, in February
2002, Telenetics filed a request for and obtained a dismissal without prejudice
in the Action.

           D. Without acknowledging the validity of any other party's rights,
claims or defenses in connection with the subject matter of the Action, and in
order for the parties to this Agreement to settle all differences between them,
and in consideration of the mutual covenants, agreements and promises set forth
in this Agreement, and other good and valuable consideration, each party to this
Agreement agrees as follows:

                                SETTLEMENT TERMS

           1. The foregoing Recitals shall be part of this Agreement.

           2. The Stock Purchase Agreement dated January 7, 2000, as amended by
that certain First Amendment to Stock Purchase Agreement dated as of May 31,
2000 (collectively, the "Stock Purchase Agreement") by and among Telenetics,
Saunders, Parker and Didion shall be amended as to Telenetics, Saunders and
Parker only (i.e., not as to Didion) pursuant to the terms of the Second
Amendment to Stock Purchase Agreement (the "Second Amendment to Stock Purchase
Agreement"), a copy of which is attached hereto as EXHIBIT A and made a part
hereof.

           3. Defendants acknowledge and agree that any and all actions taken by
Telenetics between the date of the Stock Purchase Agreement and the date of this
Agreement relating to the issuance of any capital stock of Telenetics did not
result in the application of Section 1.3(c) of the Stock Purchase Agreement (as
such was in effect prior to the deletion of such section pursuant to the Second
Amendment to Stock Purchase Agreement) and, as such, Defendants waive any rights
any of them may have with respect to the issuance of any Additional Stock (as
that term is defined in the Stock Purchase Agreement) as a result of any such
issuances of capital stock. For purposes of this Agreement, the phrase "issuance
of any capital stock of Telenetics" means (i) the issuance of any shares of
common stock of Telenetics, (ii) any grant of an option or warrant to purchase
shares of common stock of Telenetics (including any exercise of any such option
or warrant and the subsequent issuance by Telenetics of shares of common stock
underlying such option and/or warrant) and (iii) any issuance of debt
obligations of Telenetics, which debt obligations are convertible into shares of
common stock of Telenetics (including any conversion of such debt obligations
and the subsequent issuance by Telenetics of shares of common stock underlying
such debt obligations).





<PAGE>

           4. The Consulting Agreement dated as of January 7, 2000 by and
between Telenetics and S&P is hereby canceled and terminated (including any post
termination covenants contained therein) as of September 1, 2000 and any and all
obligations of Telenetics to S&P for payment thereunder, if any, shall also be
canceled, extinguished and forgiven by S&P. All amounts previously paid by
Telenetics to S&P pursuant to the terms of the Consulting Agreement are deemed
validly paid and not subject to any adjustment or forfeiture.

           5. Concurrent with the execution of this Agreement, Telenetics shall
pay to Kutak Rock, LLP, counsel for Defendants in connection with that certain
action filed in United States District Court for the Middle District of Florida,
Tampa Division (Case No. 8:00-CV-2283-T-27B), the sum of $10,000.00.

           6. Concurrent with the execution of this Agreement, Telenetics shall
execute and deliver to S&P a promissory note in the principal amount of
$24,723.42, a copy of which is attached hereto as EXHIBIT B and made a part
hereof (the "Promissory Note").

           7. Concurrent with the execution of this Agreement, Telenetics shall
pay to each of Saunders and Parker the sum of $5,000.00.

           8. Concurrent with the execution of this Agreement, S&P shall deliver
to Telenetics for cancellation all outstanding options to purchase shares of
common stock of Telenetics held by S&P.

           9. Except for any obligations imposed by this Agreement, the
Promissory Note and the Stock Purchase Agreement as amended by the Second
Amendment to Stock Purchase Agreement, Telenetics, on the one hand, and
Defendants, and each of them, on the other, and, as applicable, each of their
respective agents, successors, predecessors, parent companies, affiliated
companies, related companies, partners, officers, directors, shareholders,
representatives, employees, attorneys, insurance companies, assigns and heirs,
and each of them, past and present, hereby release and forever discharge each
other party and each of his or its respective agents, successors, predecessors,
parent companies, affiliated companies, related companies, partners, officers,
directors, shareholders, representatives, employees, attorneys, insurance
companies, assigns and heirs, and each of them, past and present, with respect
to any and all claims, demands, liabilities, obligations, debts, attorneys'
fees, costs, accounts, actions, or causes of action which any of the parties
have or claim to have as of the date of this Agreement, in law or equity,
whether known or unknown, which pertain to or which arise out of the facts,
circumstances, and/or events which are asserted, in the Action and/or which
pertain to, arise out of, or are in any connected with the past relationships
between the Parties; PROVIDED, HOWEVER, that the provisions of this Section 7
shall not apply to any claims related to or arising out of (i) McLean's
employment relationship with Telenetics and (ii) the right of the Defendants to
receive additional shares of Telenetics common stock pursuant to the terms of
the Stock Purchase Agreement as amended by the Second Amendment to Stock
Purchase Agreement.

                                       2





<PAGE>

           10. As a condition of this Agreement and in furtherance of the
release provisions set forth in this Agreement, the parties expressly waive any
and all rights and benefits conferred upon them by the provisions of section
1542 of the Civil Code of the State of California with respect to any of the
matters described or set forth in this Agreement. Section 1542 of the Civil Code
of the State of California states:

                     A general release does not extend to claims which the
                     creditor does not know or suspect to exist in his favor at
                     the time of executing the release, which if known by him
                     must have materially affected his settlement with the
                     debtor.

           The parties acknowledge that except for matters expressly represented
or recited in this Agreement, the facts and law in relation to this matter and
the claims released by the terms of this Agreement may turn out to be different
from the facts or law as now known to each party and/or his or its agents and/or
representatives, including his or its counsel. Each party expressly assumes the
risk of the existence of different or presently unknown facts or law and agrees
that this Agreement shall in all respects be effective and binding as to each
party despite the possibility of the existence of different or new facts or law.

           11. Telenetics intends to pursue its claims against Didion as set
forth in the Action. If Didion, or any assignee of Didion, asserts claims for
contribution or indemnity against Defendants in connection with Telenetics'
claims against Didion as set forth in the Action or any other litigation arising
from the facts alleged in the Action, Telenetics agrees to indemnify, defend,
and hold harmless Defendants as to such contribution or indemnity claims or any
judgment or award rendered thereon. The intent of this provision is to ensure
that Defendants will not be subject to any further liability in connection with
Telenetics' continued pursuit of claims against Didion arising from facts
alleged in the Action.

           12. Each of the parties represents and warrants that he or it has not
heretofore assigned, transferred or subrogated, or purported to assign, transfer
or subrogate, to any person or entity, any of the claims released in this
Agreement. Each of the parties agrees that he or it shall indemnify each of the
other parties, including with respect to any attorneys' fees and costs, and hold
each of the other parties harmless from and against any claims based on or
arising from any such assignment, transfer or subrogation, or any attempted
assignment, transfer or subrogation, of any of the claims released in this
Agreement.

           13. Each of the parties agrees to execute and deliver to each other
party all necessary documents and to take such additional action as may be
necessary or reasonably required to effectuate the terms, conditions,
provisions, and intent of this Agreement.

           14. Each party executing this Agreement and/or any other documents
related to the settlement between the parties represents and warrants that he or
it has been duly authorized to execute this Agreement and any such other related
documents.

                                       3





<PAGE>

           15. Each of the parties acknowledges that he or it has carefully read
this Agreement and knows and understands the contents and effect of this
Agreement, and each of the parties further acknowledges that he or it is signing
this Agreement based on his or its own free act.

           16. Each of the parties acknowledges that he or it has been advised
to seek legal counsel in connection with this matter and the provisions and
execution of this Agreement, and each of the parties acknowledges that he or it
either has consulted with his or its own legal counsel or has had a full
opportunity to consult with his or its own legal counsel in connection with the
settlement between the parties, the terms, conditions, and provisions of this
Agreement, and the execution of this Agreement.

           17. This Agreement has been entered into in the State of California,
and all of the terms, conditions and provisions of this Agreement shall be
governed by and construed and enforced in accordance with the laws of the State
of California.

           18. If any term, condition or provision of this Agreement is held to
be invalid, void or unenforceable, the remaining terms, conditions and
provisions of this Agreement nevertheless shall remain in full force and effect
and shall in no way be affected, impaired or invalidated.

           19. This Agreement and all of its terms, conditions and provisions
shall be binding upon and shall inure to the benefit of each of the parties and
each of the parties' respective heirs, successors and assigns.

           20. The prevailing party in any proceeding to enforce the provisions
of this Agreement shall be entitled to recover all costs, including reasonable
attorneys' fees, from the non-prevailing party.

           21. Each of the parties shall bear and be responsible for his or its
own attorneys' fees and costs incurred in connection with all aspects of the
Action.

           22. This Agreement contains the entire agreement and understanding
concerning the settlement between the parties and replaces any prior
negotiations or agreements between the parties, whether written and/or oral.

           23. Each of the parties agrees that no particular party or parties to
this Agreement shall be deemed to be the author of this Agreement or any
particular term, provision or condition of this Agreement. Each of the parties
further agrees that any ambiguities in this Agreement shall be resolved, and the
terms, provisions and conditions of this Agreement shall be construed and
interpreted, without regard to which party or parties may have suggested,
drafted, revised, or otherwise authored this Agreement or any of its particular
terms, provisions or conditions. Each of the parties further agrees that this
Agreement shall be construed and interpreted as if drafted jointly by all of the
parties.

           24. It is understood that this Agreement is entered into in
compromise of disputed claims and that neither the settlement between the
parties nor the performance of any of the terms, provisions, or conditions of
this Agreement shall be construed or interpreted as an admission of liability on
the part of any of the parties to this Agreement.

                                       4





<PAGE>

           25. Any disputes arising under this Agreement shall be resolved in
accordance with the laws of the State of California in either the County of
Orange or the County of Los Angeles, State of California.

           26. This Agreement may not be changed, altered or modified except in
a writing signed by each of the parties and/or duly authorized representatives
of each of the parties.

           27. This Agreement may be executed in counterparts, including
facsimile counterparts, and all such executed counterparts, including with
facsimile signatures, together shall constitute one original Agreement which
shall be binding on all of the parties to this Agreement notwithstanding that
all of the parties are not signatory to the original or the same counterparts.

           28. If the release granted to any released party by any releasing
party in this Agreement is held by a court of competent jurisdiction to be void
or unenforceable, then the release given by that released party to that
releasing party shall also be deemed void and unenforceable.

Dated:  September 27, 2002                TELENETICS CORPORATION

                                          By: /S/ David Stone
                                              ---------------------------------
                                               David Stone, President and Chief
                                               Financial Officer

                                          /S/ JOHN D. MCLEAN
Dated:  September 27, 2002                --------------------------------------
                                          JOHN D. MCLEAN

                                          /S/ WILLIAM C. SAUNDERS
Dated:  September 27, 2002                --------------------------------------
                                          WILLIAM C. SAUNDERS

                                          /S/ TERRY S. PARKER
Dated:  September 27, 2002                --------------------------------------
                                          TERRY S. PARKER

Dated:  September 27, 2002                SAUNDERS & PARKER, INC.

                                          By:/S/ WILLIAM C. SAUNDERS
                                             -----------------------------------
                                               Its: CO-PRES
                                                   -----------------------------

                                       5





<PAGE>

APPROVED AS TO FORM:

RUTAN & TUCKER, LLP

By:  /S/  Larry A. Cerutti
     ------------------------------------
           Larry A. Cerutti
Attorneys for Telenetics Corporation

MUNSCH HARDT KOPF & HARR, P.C.

By:  /S/ Sally A. Schreiber
     ------------------------------------
           Sally A. Schreiber
Attorneys for Terry S. Parker, William C.
Saunders and Saunders & Parker, Inc.

                                       6