RNAi is a widespread mechanism by which organisms regulate gene expression and defend their genomes against viruses and transposable elements. Here we report the identification of Drosophila zucchini (zuc) and squash (squ), which function in germline RNAi processes. Zuc and Squ contain domains with homologies to nucleases. Mutant females are sterile and show dorsoventral patterning defects during oogenesis. In addition, Oskar protein is ectopically expressed in early oocytes, where it is normally silenced by RNAi mechanisms. Zuc and Squ localize to the perinuclear nuage and interact with Aubergine, a PIWI class protein. Mutations in zuc and squ induce the upregulation of Het-A and Tart, two telomere-specific transposable elements, and the expression of Stellate protein in the Drosophila germline. We show that these defects are due to the inability of zuc and squ mutants to produce repeat-associated small interfering RNAs.