10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 27, 2008

OR

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission file number 0-13470

NANOMETRICS INCORPORATED

(Exact name of registrant as specified in its charter)

Delaware	94-2276314
(State or other jurisdiction of incorporation or organization)	(I. R. S. Employer Identification No.)
1550 Buckeye Drive, Milpitas, CA	95035
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (408) 545-6000

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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨	Accelerated filer  x	Non-accelerated filer  ¨	Smaller reporting company  ¨
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of October 31, 2008, there were 18,297,003 shares of common stock, $0.001 par value, issued and outstanding.

NANOMETRICS INCORPORATED

INDEX TO QUARTERLY REPORT ON FORM 10-Q

FOR QUARTER ENDED SEPTEMBER 27, 2008

			Page
PART I.		FINANCIAL INFORMATION	3
	Item 1.	Financial Statements (Unaudited)	3
		Consolidated Balance Sheets at September 27, 2008 and December 29, 2007	3
		Consolidated Statements of Operations for the Three- and Nine-Month Periods Ended September 27, 2008 and September 29, 2007	4
		Consolidated Statements of Cash Flows for the Nine-Month Periods Ended September 27, 2008 and September 29, 2007	5
		Notes to Consolidated Financial Statements	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
	Item 4.	Controls and Procedures	26
PART II.		OTHER INFORMATION	27
	Item 1.	Legal Proceedings	27
	Item 1A.	Risk Factors	27
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	36
	Item 4.	Submission of Matters to a Vote of Securities Holders	36
	Item 6.	Exhibits	36
Exhibit Index			36
Signatures			38

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PART I — FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

NANOMETRICS INCORPORATED

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands except share amounts)

(Unaudited)

	September 27, 2008			December 29, 2007
ASSETS
Current assets:
Cash and cash equivalents	$	21,779		$	14,919
Accounts receivable, net of allowances of $311 and $323, respectively		21,333			34,855
Inventories		33,951			33,343
Inventories- delivered systems		175			785
Prepaid expenses and other		2,743			2,598
Total current assets		79,981			86,500
Property, plant and equipment, net		42,181			44,419
Goodwill and indefinite lived intangible asset		—			52,532
Intangible assets, net		7,224			21,820
Other assets		1,816			1,805
Total assets	$	131,202		$	207,076
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Revolving line of credit	$	—		$	—
Accounts payable		8,055			13,931
Accrued payroll and related expenses		3,804			4,514
Deferred revenue		988			2,501
Other current liabilities		7,750			7,243
Income taxes payable		244			1,101
Current portion of debt obligations		468			148
Total current liabilities		21,309			29,438
Deferred income taxes		382			382
Other long-term liabilities		558			1,283
Debt obligations		13,162			129
Total liabilities		35,411			31,232
Commitments and Contingencies
Stockholders’ Equity:
Preferred stock, $0.001 par value; 3,000,000 shares authorized; none issued and outstanding		—			—
Common stock, $0.001 par value, 47,000,000 shares authorized; 18,297,003 and 18,620,682, respectively, issued and outstanding		18			19
Additional paid-in capital		189,086			187,180
Accumulated deficit		(94,002	)		(13,917	)
Accumulated other comprehensive income		689			2,562
Total stockholders’ equity		95,791			175,844
Total liabilities and stockholders’ equity	$	131,202		$	207,076

See Notes to Unaudited Consolidated Financial Statements

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NANOMETRICS INCORPORATED

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands except per share amounts)

(Unaudited)

	Three-Months Ended						Nine-Months Ended
	September 27, 2008			September 29, 2007			September 27, 2008			September 29, 2007
Net revenues:
Products	$	16,311		$	33,306		$	62,744		$	98,564
Service		6,826			5,341			18,882			14,533
Total net revenues		23,137			38,647			81,626			113,097
Costs of net revenues:
Cost of products		8,150			16,773			30,974			50,628
Cost of service		4,778			4,791			14,548			15,459
Total costs of net revenues		12,928			21,564			45,522			66,087
Gross profit		10,209			17,083			36,104			47,010
Operating expenses:
Research and development		4,430			4,661			13,107			13,986
Selling		4,280			4,603			13,963			14,636
General and administrative		4,935			4,783			15,761			16,538
Amortization of intangible assets		600			1,285			3,215			4,497
Restructuring charge		655			2,128			1,525			2,128
Asset impairment		55,332			—			68,545			—
Gain on sale of assets		—			(2,100	)		—			(2,100	)
Total operating expenses		70,232			15,360			116,116			49,685
Income (loss) from operations		(60,023	)		1,723			(80,012	)		(2,675	)
Other income (expense)
Interest income		24			69			156			121
Interest expense		(240	)		(56	)		(343	)		(141	)
Other, net		142			382			564			(40	)
Total other income (expense), net		(74	)		395			377			(60	)
Income (loss) before provision (benefit) for income taxes		(60,097	)		2,118			(79,635	)		(2,735	)
Provision (benefit) for income taxes		350			110			450			(2	)
Net income (loss)	$	(60,447	)	$	2,008		$	(80,085	)	$	(2,733	)
Net income (loss) per share:
Basic	$	(3.25	)	$	0.11		$	(4.31	)	$	(0.15	)
Diluted	$	(3.25	)	$	0.11		$	(4.31	)	$	(0.15	)
Shares used in per share calculation:
Basic		18,574			18,278			18,599			17,931
Diluted		18,574			18,676			18,599			17,931

See Notes to Unaudited Consolidated Financial Statements.

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NANOMETRICS INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

	Nine-Months Ended
	September 27, 2008			September 29, 2007
Cash flows from operating activities:
Net loss	$	(80,085	)	$	(2,733	)
Reconciliation of net loss to net cash provided by operating activities:
Depreciation and amortization		6,085			6,983
Asset impairment		68,545			—
Stock-based compensation		3,137			2,749
Gain on sale of assets		—			(2,100	)
Non-cash portion of restructuring charge		—			1,910
Changes in assets and liabilities, net of assets acquired:
Accounts receivable		13,664			(8,949	)
Inventories, net		(380	)		851
Inventories-delivered systems		610			3,736
Prepaid expenses and other		(60	)		(984	)
Other assets		(165	)		183
Accounts payable, accrued and other liabilities		(7,155	)		5,692
Deferred revenue		(1,657	)		(4,342	)
Income taxes payable		(724	)		(103	)
Net cash provided by operating activities		1,815			2,893
Cash flows from investing activities:
Purchase of Tevet’s net assets, net of cash received		(3,357	)		—
Purchases of property, plant and equipment		(2,762	)		(1,045	)
Proceeds from sale of assets		—			3,863
Net cash provided by (used) in investing activities		(6,119	)		2,818
Cash flows from financing activities:
Proceeds from issuance of debt obligations		13,500			—
Repayments of debt obligations		(136	)		(1,500	)
Proceeds from sale of shares under employee stock option plans and purchase plan		604			3,118
Repurchases of common stock		(1,836	)		(198	)
Net cash provided by financing activities		12,132			1,420
Effect of exchange rate changes on cash and cash equivalents		(968	)		(214	)
Net increase in cash and cash equivalents		6,860			6,917
Cash and cash equivalents, beginning of period		14,919			7,957
Cash and cash equivalents, end of period	$	21,779		$	14,874
Supplemental disclosure of cash flow information:
Cash for interest	$	163		$	122
Cash paid for income taxes	$	693		$	175
Capitalization of inventory as property, plant and equipment	$	—		$	5,775
Goodwill adjustment	$	—		$	2,332

See Notes to Unaudited Consolidated Financial Statements.

5

NANOMETRICS INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Consolidated Financial Statements

In the opinion of management, the accompanying Unaudited Consolidated Financial Statements (“financial statements”) of Nanometrics Incorporated and its wholly-owned subsidiaries (collectively, “Nanometrics” or the “Company”) have been prepared on a consistent basis with the December 29, 2007 audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly present the information set forth therein. The financial statements have been prepared in accordance with the regulations of the United States Securities and Exchange Commission (“SEC”), and, therefore, omit certain information and footnote disclosure necessary to present the statements in accordance with accounting principles generally accepted in the United States of America. The operating results for interim periods are not necessarily indicative of the operating results that may be expected for the entire year. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 29, 2007, which were included in the Company’s Annual Report on Form 10-K, which was filed with the SEC on March 13, 2008 and amended on April 25, 2008.

Fiscal Period – Nanometrics uses a 52/53 week fiscal year ending on the Saturday nearest to December 31. All references to the quarter refer to Nanometrics’ fiscal quarter. The fiscal quarters presented herein include 13 weeks.

Note 2. Recent Accounting Pronouncements

In April 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. 142-3, “Determination of the Useful Life of Intangible Assets”, (“FSP 142-3”) that amends the factors considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under Statement of Financial Accounting Standards (“SFAS”) SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). FSP 142-3 requires a consistent approach between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of an asset under SFAS No. 141 (R), “Business Combinations” (“SFAS 141R”). The FSP also requires enhanced disclosures when an intangible asset’s expected future cash flows are affected by an entity’s intent and/or ability to renew or extend the arrangement. FSP 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and is applied prospectively. Early adoption is prohibited. The Company does not expect the adoption of FSP 142-3 to have a material impact on its consolidated results of operations or financial condition.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of non-governmental entities that are presented in conformity with generally accepted accounting principles in the United States of America. SFAS 162 became effective on November 15, 2008. The Company does not anticipate the adoption of SFAS 162 will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In March 2008, the FASB issued SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133” (“SFAS 161”). The new standard requires additional disclosures regarding a company’s derivative instruments and hedging activities by requiring disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also requires disclosure of derivative features that are credit risk–related as well as cross-referencing within the notes to the financial statements to enable financial statement users to locate important information about derivative instruments, financial performance, and cash flows. The standard is effective for the Company’s fiscal year and interim periods within such year, beginning January 1, 2009, with early application encouraged. The Company does not anticipate the adoption of SFAS 161 will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In December 2007, the FASB issued SFAS 141R, “Business Combinations” which amends SFAS 141 and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any non-controlling interest in the acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. It is effective for fiscal years beginning on or after December 15, 2008 and will be applied prospectively. The Company does not anticipate the adoption of SFAS 141 will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

6

In December 2007, the FASB issued SFAS No. 160, “Non-controlling interests in Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 requires that ownership interests in subsidiaries held by parties other than the parent, and the amount of consolidated net income, be clearly identified, labeled, and presented in the consolidated financial statements. It also requires once a subsidiary is deconsolidated, any retained non-controlling equity investment in the former subsidiary be initially measured at fair value. Sufficient disclosures are required to clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. It is effective for fiscal years beginning on or after December 15, 2008 and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements shall be applied prospectively. The Company is currently evaluating the impact of adopting SFAS 160 on its consolidated financial statements.

In September 2006, the FASB finalized SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements; however, it does not require any new fair value measurements. In February 2008, the FASB issued FSP No. 157-2, Effective Date of FASB Statement 157” (“FSP 157-2”). Effective upon issuance, FSP 157-2 delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. FSP 157-2 also covers interim periods within the fiscal years for items within its scope. The delay is intended to allow the FASB and its constituents the time to consider the various implementation issues associated with SFAS 157. The Company is currently evaluating the impact of adopting SFAS 157 for non-financial assets and liabilities on its consolidated financial statements.

Note 3. Acquisitions

On May 19, 2008, Nanometrics announced that it had acquired Tevet Process Control Technologies, Ltd., (“Tevet”) an Israel-based privately held corporation. The acquisition of Tevet, an integrated metrology company serving the worldwide semiconductor and solar manufacturing industry, is expected to further Nanometrics’ strategy to offer a breadth of process control metrology solutions that address both advanced technology as well as cost of ownership. Under the terms of the asset purchase agreement, which was an all-cash transaction, the total consideration to purchase all assets and assume specified liabilities of Tevet was $3.8 million, including $0.2 million in transaction fees, which include legal, valuation and accounting fees. The asset purchase has been accounted for under the purchase method of accounting in accordance with SFAS 141, “Business Combinations”. Under the purchase method of accounting, the total estimated purchase price is allocated to the net tangible and identifiable intangible assets of Tevet acquired in connection with the transaction, based on their respective estimated fair values. The results of operations of Tevet were included in the Company’s consolidated statements of operations from the date of the acquisition.

The preliminary allocation of the Tevet purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed was based on management’s estimates of fair value at the date of acquisition. When estimating fair values of assets acquired and liabilities assumed, management considered a number of factors, including valuations, appraisals and assumptions which are subject to change. The primary areas of the purchase price allocation that are not yet finalized relate to finalization of the valuation report. Management expects the valuation process to be completed during the fourth quarter of fiscal 2008.

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The preliminary allocation of the Tevet purchase price is summarized below (in thousands):

Assets acquired:
Cash	$	446
Accounts receivable		49
Inventories		467
Other assets		70
Property, plant and equipment		169
Total assets acquired		1,201
Liabilities assumed:
Accounts payable		159
Deferred revenue		250
Other accrued liabilities		336
Total liabilities assumed		745
Net assets acquired		456
Goodwill and other intangible assets:
Goodwill		1,848
Customer relationships		669
Developed technology		600
Backlog		230
Total goodwill and other intangible assets		3,347
Net estimated purchase price	$	3,803

The developed technology and customer relationships are being amortized over an estimated useful life of seven years and the customer relationships is being amortized on an accelerated basis over an estimated useful life designed to match the amortization to the benefits where applicable. In accordance with SFAS 142, the Company concluded that events had occurred and circumstances had changed during the third quarter of 2008 which indicated the existence of impairment indicators. Consistent with the Company’s approach in its annual impairment test the Company performed an impairment test which resulted in no implied fair value of the goodwill, and therefore, the Company recognized an impairment charge of $54.0 million including $1.8 million in goodwill arising from Tevet acquisition in the third quarter of 2008, representing a write-off of the entire amount of the Company’s previously recorded goodwill.

If the Company had acquired Tevet at the beginning of the periods presented, the Company’s unaudited pro forma net revenues, net income/loss and net income/loss per share from operations would have been as follows (in thousands, except per share amounts):

	Three Months Ended					Nine Months Ended
	September 27, 2008			September 29, 2007		September 27, 2008			September 29, 2007
Net revenues	$	23,137		$	39,304	$	82,447		$	114,560
Net income (loss)		(60,447	)		1,473		(80,545	)		(5,048	)
Net income (loss) per share:
Basic	$	(3.25	)	$	0.08	$	(4.33	)	$	(0.28	)
Diluted	$	(3.25	)	$	0.08	$	(4.33	)	$	(0.28	)

Note 4. Asset Impairment

Goodwill

Goodwill represents the excess of the purchase price paid over the fair value of tangible and identifiable intangible net assets acquired in a business combination. In accordance with SFAS 142 goodwill is reviewed annually or whenever events or circumstances occur which indicate that goodwill might be impaired. SFAS 142 provides for a two-step approach to determining whether and by how much goodwill has been impaired. The first step requires a comparison of the fair value of the Company (reporting unit) to its net book value. If the fair value is greater, then no impairment is deemed to have occurred. If the fair value is less, then the second step must be performed to determine the amount, if any, of actual

8

impairment. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment. In estimating the fair value of the Company, the Company made estimates and judgments about future revenues and cash flows for each reporting unit. To determine the fair value, the Company’s review process includes the income method and is based on a discounted future cash flow approach that uses estimates including the following for each reporting unit: revenue, based on assumed market growth rates and its assumed market share; estimated costs; and appropriate discount rates based on the particular business’s weighted average cost of capital. The Company’s estimates of market segment growth, market segment share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates it uses to manage the underlying businesses. The Company’s business consists of both established and emerging technologies and its forecasts for emerging technologies are based upon internal estimates and external sources rather than historical information. The Company also considered its market capitalization on the dates of its impairment tests in determining the fair value of the respective businesses. The Company completed the first step at June 28, 2008 and determined that the fair value of its reporting units was in excess of the net book value on that date.

In accordance with SFAS 142, the Company concluded that events had occurred and circumstances had changed during the third quarter of 2008 which might indicate the existence of impairment indicators including a significant decline in the Company’s stock price and continued deterioration in the semiconductor equipment market and the related impact on revenue forecasts of each reporting unit. Consistent with the Company’s approach in its annual impairment testing, in assessing the fair value of the reporting unit, the Company considered both the market approach and income approach. Under the market approach, the fair value of the reporting unit is based on quoted market prices and the number of shares outstanding of the Company’s common stock. Under the income approach, the fair value of the reporting unit is based on the present value of estimated future cash flows. At September 27, 2008, the Company determined that the fair value of its reporting units was less than the net book value of the net assets of each reporting unit and accordingly, the Company performed step two of the impairment test.

In step two of the impairment test, the Company determined the implied fair value of the goodwill and compared it to the carrying value of the goodwill. With the assistance of a third party valuation firm, the Company allocated the fair value of the reporting units to all of its assets and liabilities as if the reporting unit had been acquired in a business combination and the fair value of the reporting units was the price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amount assigned to its assets and liabilities is the implied fair value of goodwill. The Company’s step two analysis resulted in no implied fair value of goodwill, and therefore, the Company recognized an impairment charge of $54.0 million in the third quarter of 2008, representing a write-off of the entire amount of the Company’s previously recorded goodwill including goodwill from the Tevet acquisition which was a part of the impaired reporting units.

Long-Lived Assets

The Company performs an impairment review of its long-lived assets upon a change in business conditions or upon the occurrence of an indicator of impairment. Due to changes in the forecasts relating to specific intangible assets acquired in the 2006 acquisitions caused by management’s decision to focus the Company’s resources on new generation products, and changes in the forecasts relating to the machine shop, the Company performed an analysis in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets” (“SFAS 144”), of its long-lived assets including intangible assets and other long-lived assets where cash flows could be identified with a specific group of assets. SFAS 144 provides for a two-step approach to determine whether and by how much a long-lived asset has been impaired. The first step requires a comparison of the future undiscounted cash flows of the asset to its net book value. If the undiscounted future cash flows are greater, then no impairment is deemed to have occurred. If the undiscounted future cash flows are less, then the second step must be performed to determine the amount, if any, of actual impairment. The Company performed step one of the impairment test for certain of its long-lived assets as of June 28, 2008, and determined that the net book value exceeded the undiscounted future cash flows for certain intangible assets as well as assets associated with the Company’s machine shop and plating facility which was subcontracted in the third quarter of 2007. The initial projected future cash flows from subcontracting this facility has been significantly reduced due to operational limitations. Accordingly, the Company completed step two of the impairment analysis utilizing a present value technique to estimate the fair value of the impaired assets. As a result of this analysis, impairment charges of $11.8 million and $1.5 million, respectively, were recorded in the second quarter of 2008 to reflect certain customer relationships, brand names, developed technology intangible assets and machine shop related assets at their fair value.

Due to the continuing deterioration in the semiconductor equipment market, during the third quarter 2008, the Company’s forecasted revenues have declined for certain product lines relating to specific intangible assets acquired in the 2006 acquisition of Accent Optical Technologies, Inc. The Company performed an analysis in accordance with SFAS 144 of

9

its long-lived intangible assets where cash flows could be identified with a specific group of assets. The Company performed step one of the impairment test for the specified intangible assets and has determined that at September 27, 2008, the net book value exceeded the undiscounted future cash flows. Accordingly, the Company completed step two of the impairment analysis utilizing a present value technique to estimate the fair value of the impaired assets. As a result of this analysis, an impairment charge of $1.4 million was recorded in the third quarter of 2008 to reflect certain brand names and developed technology intangible assets at their fair value.

The process of evaluating the potential impairment of long-lived assets is highly subjective and requires significant judgment. In estimating the fair value of these assets, the Company made estimates and judgments about future revenues and cash flows. The Company’s forecasts were based on assumptions that are consistent with the plans and estimates the Company is using to manage the business. Changes in these estimates could change the Company’s conclusion regarding impairment of the long-lived assets and potentially result in future impairment charges for all or a portion of their balance at September 27, 2008.

Note 5. Restructuring Charge

During the first and third quarters of 2008, the Company reduced its global work force by approximately 30 and 34 employees, respectively. This reduction affected employees in each of the Company’s locations worldwide and is aimed at reducing its operating expenses.

	Other Charges			Severance and Other Benefits			Total
Restructuring charges recorded during the first quarter of 2008	$	84		$	786		$	870
Cash paid		(84	)		(786	)		(870	)
Reserve balance at March 29, 2008	$	—		$	—		$	—
Restructuring charges recorded during the third quarter of 2008	$	—		$	655		$	655
Cash paid		—			(377	)		(377	)
Reserve balance at September 27, 2008	$	—		$	278		$	278

The Company anticipates that the remaining restructuring reserve balance of $0.3 million will be paid or utilized by December 27, 2008. The balance is reflected in “Other current liabilities” in the accompanying unaudited consolidated balance sheet.

During the third quarter of 2007, the Company announced it would close its Milpitas, California machine shop and plating facility as part of its strategy to reverse its manufacturing vertical integration and lower its breakeven point. In conjunction with this closure, Nanometrics recorded a restructuring charge in an amount of $2.1 million consisting of $1.9 million write-down of property, plant and equipment, $0.1 million for professional fees and $0.1 million for severance payments.

	Professional Fees			Severance and Other Benefits			Other Charges			Total
Restructuring charges recorded during the third quarter of 2007	$	126		$	92		$	1,910		$	2,128
Non-cash charges		—			—			(1,910	)		(1,910	)
Cash paid		(84	)		(84	)		—			(168	)
Reserve balance at September 29, 2007	$	42		$	8		$	—		$	50

The remaining restructuring reserve balance of $0.1 million was paid or utilized by December 29, 2007.

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Note 6. Accounts Receivable

The Company maintains arrangements under which eligible accounts and notes receivable are sold without recourse to unrelated third-party financial institutions. These receivables were not included in the consolidated balance sheets as the criteria for sale treatment established by SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” (“SFAS 140”) had been met. Under SFAS 140, after a transfer of financial assets, an entity stops recognizing the financial assets when the control has been surrendered. The Company’s sale of accounts receivable met the criteria of a true sale of these assets since the acquiring party retained the title to these receivables and had assumed the risk that the receivables will be collectible. The Company pays administrative fees as well as interest at rates ranging from 1.875% to 1.890% based on the anticipated length of time between the date the sale is consummated and the expected collection date of the receivables sold. The Company sold $5.9 million and $16.4 million of receivables, respectively, during the three- and nine-month periods ended September 27, 2008, and sold $5.7 million and $15.2 million of receivables, respectively, during the three- and nine-month periods ended September 29, 2007. There were no material gains or losses on the sale of such receivables. There were no amounts due from the financial institutions at September 27, 2008 and December 29, 2007.

Note 7. Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market and consist of the following (in thousands):

	September 27, 2008		December 29, 2007
Raw materials and sub-assemblies	$	18,545	$	19,685
Work in process		6,186		7,134
Finished goods		9,220		6,524
Total inventories	$	33,951	$	33,343

We reflect the cost of systems that were invoiced upon shipment but deferred for revenue recognition purposes separate from our inventory held for sale as “Inventories—delivered systems.”

Note 8. Property, Plant and Equipment

Property, plant and equipment consists of the following (in thousands):

	September 27, 2008			December 29, 2007
Land	$	15,584		$	15,597
Building and improvements		21,318			18,188
Machinery and equipment		20,005			18,753
Furniture and fixtures		2,270			2,185
		59,177			54,723
Accumulated depreciation and amortization		(16,996	)		(10,304	)
Total property, plant and equipment, net	$	42,181		$	44,419

Note 9. Intangible Assets

Intangible assets with an indefinite life are evaluated annually for impairment or whenever events or circumstances occur which indicate that those assets might be impaired. On March 15, 2006, as a result of the Company’s acquisition of Soluris Inc., the Company acquired a trademark with a value of $0.4 million with an indefinite life. During the first quarter of 2008, the Company determined the trademark no longer had an indefinite life. Accordingly, a remaining life of five years was assigned and the Company began amortization of the finite-lived intangible asset.

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During the second quarter of 2008, the Company added $1.5 million of finite-lived intangible assets through its acquisition of Tevet. Finite-lived intangible assets are recorded at cost, less accumulated amortization. Finite-lived intangible assets as of September 27, 2008 and December 29, 2007 consist of the following (in thousands):

	Original Amount		(A) Impairment and Tax Adjustment			Adjusted Basis		Accumulated Amortization			Net Carrying Amount
September 27, 2008
Developed technology	$	10,400	$	(3,790	)	$	6,610	$	(2,921	)	$	3,689
Customer relationships		16,369		(7,479	)		8,890		(6,271	)		2,619
Brand names		3,600		(1,671	)		1,929		(1,051	)		878
Patented technology		1,790		—			1,790		(1,790	)		—
Trade Mark		400		(320	)		80		(42	)		38
Backlog		3,361		—			3,361		(3,361	)		—
Non-compete agreement		50		—			50		(50	)		—
Other		250		—			250		(250	)		—
Total	$	36,220	$	(13,260	)	$	22,960	$	(15,736	)	$	7,224
December 29, 2007
Developed technology	$	9,800	$	—		$	9,800	$	(2,037	)	$	7,763
Customer relationships		15,700		—			15,700		(4,638	)		11,062
Brand names		3,600		—			3,600		(749	)		2,851
Patented technology		1,790		—			1,790		(1,646	)		144
Backlog		3,131		—			3,131		(3,131	)		—
Non-compete agreement		50		—			50		(50	)		—
Other		250		—			250		(250	)		—
Total	$	34,321	$	—		$	34,321	$	(12,501	)	$	21,820

(A) Amounts include impairments charges recorded in the second and third quarters of 2008 of $11.8 million and $1.4 million, respectively and tax adjustment of $0.1 million in the third quarter of 2008.

The amortization of finite-lived intangibles is computed using the straight-line method except for customer relationships which is computed using an accelerated method. Estimated lives of finite-lived intangibles range from five to ten years, except for the non-compete agreement and backlog which were amortized over one year. Total amortization expense for the three-month periods ended September 27, 2008 and September 29, 2007 was $0.6 million and $1.3 million, respectively, and for the nine-month periods ended September 27, 2008 and September 29, 2007 was $3.2 million and $4.5 million, respectively.

The estimated future amortization expense as of September 27, 2008 is as follows (in thousands):

Fiscal Years
2008 (remaining three months)	$	316
2009		1,519
2010		1,338
2011		1,104
2012		929
Thereafter		2,018
Total amortization	$	7,224

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Note 10. Other Current Liabilities

Other current liabilities consist of the following (in thousands):

	September 27, 2008		December 29, 2007
Accrued warranty	$	2,568	$	4,545
Accrued professional services		1,181		529
Consumption/value added tax		1,233		12
Other		2,768		2,157
Total other current liabilities	$	7,750	$	7,243

Note 11. Debt Obligations

Debt obligations consist of the following (in thousands):

	September 27, 2008			December 29, 2007
Milpitas building mortgage	$	13,476		$	—
Equipment financing		154			277
Total debt obligations		13,630			277
Current portion of debt obligations		(468	)		(148	)
Long-term debt obligations	$	13,162		$	129

In July 2008, the Company entered into a borrowing facility in the principal amount of $13.5 million maturing in July 2018. All borrowings under this facility bear a fixed interest for five years at a per annum rate equal to 7.18% whereupon the interest rate will be reset to a fixed rate for the following five years equal to the weekly average yield of five year U.S. dollar interest rate swaps in effect plus 3.03%. The loan is collateralized by a lien on the building and land comprising of the Company’s principal offices in Milpitas, California.

The equipment financing was obtained by the Company’s subsidiary in the United Kingdom and is collateralized by the financed assets. The loan is denominated in British pound sterling (£138,745 at December 29, 2007) and bears interest at 5.53% per annum. The loan is payable in monthly installments with unpaid principal and interest due in November 2009.

The Company is not in breach of any restrictive covenants in connection with its debt. At September 27, 2008, future annual maturities of debt obligations were as follows (in thousands):

2008 (remaining three months)	$	115
2009		451
2010		357
2011		383
2012		412
Thereafter		11,912
Total	$	13,630

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Note 12. Stockholders’ Equity

Net Income (Loss) Per Share—Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income per share gives effect to all potentially dilutive common shares outstanding during the period, including contingently issuable shares and certain stock options, calculated using the treasury stock method. A reconciliation of the share denominator of the basic and diluted net income (loss) per share computations is as follows (in thousands):

	Three-Months Ended		Nine-Months Ended
	September 27, 2008	September 29, 2007	September 27, 2008	September 29, 2007
Weighted average common shares outstanding used in basic net loss per share computation	18,574	18,278	18,598	17,931
Contingently issuable shares in connection with the Accent acquisition	—	276	—	—
Potential dilutive common stock equivalents, using treasury stock method	—	122	—	—
Shares used in diluted net loss per share computation	18,574	18,676	18,598	17,931

For the three- and nine-month periods ended September 27, 2008 and September 29, 2007, the Company had securities outstanding which could potentially dilute basic earnings per share in the future, which were excluded from the computation of diluted net income (loss) per share in the periods presented as their impact would have been anti-dilutive. Weighted average common share equivalents, consisting of stock options excluded from the calculation of diluted net income(loss) per share were 3.0 million and 2.7 million for the three-month periods ended September 27, 2008 and September 29, 2007, respectively and were 2.8 million and 2.7 million in the nine-month period ended September 27, 2008 and September 29, 2007 .

During the third fiscal quarter of 2007, the Company’s Board of Directors authorized a stock repurchase program pursuant to which the Company may repurchase up to $4.0 million of its common stock. The Company repurchased 461,057 and 26,455 common shares, respectively, at an average price of $3.98 and $7.47 per share during the nine-month periods ended September 27, 2008 and September 29, 2007.

Note 13. Stock-Based Compensation

Stock-based compensation expense for all share-based payment awards made to the Company’s employees and directors pursuant to the employee stock option and employee stock purchase plans under SFAS No. 123 (revised 2004), “Share-Based Payment”, (“SFAS 123(R)”)is as follows (in thousands):

	Three-Months Ended				Nine-Months Ended
	September 27, 2008		September 29, 2007		September 27, 2008		September 29, 2007
Cost of products	$	115	$	103	$	251	$	216
Cost of service		116		103		301		268
Research and development		216		231		527		762
Selling		186		140		592		577
General and administrative		505		296		1,466		926
Total stock-based compensation expense related to employee stock options and employee stock purchase plans	$	1,138	$	873	$	3,137	$	2,749

The fair value of each option award is estimated on the date of grant using the Black-Scholes valuation model and the assumptions noted in the following table. The expected term of options granted was calculated using the simplified method allowed by Staff Accounting Bulletin 107. The risk-free rate is based on the U.S. Treasury rates in effect during the corresponding period of grant. The expected volatility is based on the historical volatility of Nanometrics’ stock price. The dividend yield reflects that the Company has not paid any cash dividends since inception and does not intend to pay any cash dividends in the foreseeable future.

	Three-Months Ended				Nine-Months Ended
	September 27, 2008		September 29, 2007		September 27, 2008		September 29, 2007
Stock Options
Expected life	3.94 years		4.5 years		4.2 years		4.4 years
Volatility	55.18	%	58.40	%	54.42	%	59.8	%
Risk free interest rate	2.97	%	5.15	%	2.97	%	5.10	%
Dividends	—		—		—		—
Employee Stock Purchase Plan
Expected life	0.5 years		0.5 years		0.5 years		0.5 years
Volatility	72.93	%	34.0	%	72.93	%	37.90	%
Risk free interest rate	1.64	%	2.20	%	1.64	%	3.12	%
Dividends	—		—		—		—

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The weighted average fair value per share of the stock options awarded in the three- and nine-month periods ended September 27, 2008 was $2.08 and $2.77, respectively, based on the fair market value of the Company’s common stock on the grant dates.

A summary of activity under the Company’s stock option plans during the nine months ended September 27, 2008 is as follows:

	Shares Available (Options and RSU’s)		Number of Shares (Options)		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value (in Thousands)
Options
Outstanding at December 29, 2007	1,607,911		3,120,467		$	9.94	4.6	$	4,381
Shares added through 2005 Option Plan	558,620		—
Exercised			(35,978	)
Granted	(506,466	)	506,466
RSU Allocation	(20,000	)	—
Cancelled	625,047		(628,307	)
Outstanding at September 27, 2008	2,265,112		2,962,648		$	9.25	4.53	$	12
Exercisable at September 27, 2008			1,722,848		$	10.23	3.7	$	12

During the nine-month period ended September 27, 2008, the Company granted 20,000 Restricted Stock Units (“RSUs”) with vesting periods of three years. As of September 27, 2008, there were 51,333 RSUs outstanding.

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the Company’s closing stock price of $2.34 as of September 27, 2008, which would have been received by the option holders had all option holders exercised their options as of that date. The total intrinsic value of options exercised during the three- and nine-month periods ended September 27, 2008 was $0.1 million and total intrinsic value of options exercised during the three- and nine-month periods ended September 29, 2007 was $0.1 million and $0.4 million respectively. The fair value of options vested for the three- and nine-month periods ended September 27, 2008 was $1.7 million and $5.1 million, respectively, and for the three- and nine-month periods ended September 29, 2007 was $1.6 million and $3.2 million, respectively.

Note 14. Comprehensive Income (Loss)

The Company’s comprehensive income (loss) was as follows (in thousands):

	Three-Months Ended					Nine-Months Ended
	September 27, 2008			September 29, 2007		September 27, 2008			September 29, 2007
Net loss	$	(60,447	)	$	2,008	$	(80,085	)	$	(2,733	)
Foreign currency translation adjustments, net of tax		(1,551	)		678		(1,873	)		768
Total comprehensive income (loss)	$	(61,998	)	$	2,686	$	(81,958	)	$	(1,965	)

Substantially all of the accumulated other comprehensive income reflected as a separate component of stockholders’ equity consists of accumulated foreign currency translation adjustment for all periods presented.

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Note 15. Warranties

Product Warranty – The Company sells the majority of its products with a 12-month repair or replacement warranty from the date of acceptance which generally represents the date of shipment. The Company provides an accrual for estimated future warranty costs based upon the historical relationship of warranty costs to the cost of products sold. The estimated future warranty obligations related to product sales are recorded in the period in which the related revenue is recognized. The estimated future warranty obligations are affected by the warranty periods, sales volumes, product failure rates, material usage, and labor and replacement costs incurred in correcting a product failure. If actual product failure rates, material usage, labor or replacement costs differ from the Company’s estimates, revisions to the estimated warranty obligations would be required. For new product introductions where limited or no historical information exists, the Company may use warranty information from other previous product introductions to guide it in estimating its warranty accrual. The warranty accrual represents the best estimate of the amount necessary to settle future and existing claims on products sold as of the balance sheet date. The Company periodically assesses the adequacy of its reported warranty reserve and adjusts the amounts in accordance with changes in these factors. Components of the warranty accrual, which was included in the accompanying consolidated balance sheets with other current liabilities, were as follows (in thousands):

	Nine-Months Ended
	September 27, 2008			September 29, 2007
Balance as of beginning of period	$	4,545		$	4,349
Warranty settlements		(4,226	)		(2,989	)
Provision for warranty		2,249			3,361
Balance as of end of period	$	2,568		$	4,721

Intellectual Property Indemnification Obligations – In addition to product warranties, the Company will, from time to time, in the normal course of business, agree to indemnify certain customers with whom it enters into contractual relationships. The Company has agreed to hold these customers harmless against third party claims that Nanometrics’ products, when used for their intended purpose(s), infringe the intellectual property rights of such third parties or other claims made against the customer. It is not possible to determine the maximum potential amount of liability under these indemnification obligations due to the limited history of prior indemnification claims and the unique facts and circumstances that are likely to be involved in each particular claim. Historically, the Company has not made payments under these obligations and believes that the estimated fair value of these agreements is minimal. Accordingly, no liabilities have been recorded for these obligations in the accompanying unaudited consolidated balance sheets as of September 27, 2008 and December 29, 2007.

Note 16. Gain on the Sale of Assets

In August 2007 the Company entered into a contract to sell a parcel of land and building in Japan and realized a gain on the sale of $1.1 million. In addition, the sale of a condominium in California was consummated in July 2007 and the Company realized a gain of $0.2 million in the third quarter of 2007. We also sold other non-strategic assets during the third quarter of 2007 realizing a gain of $0.8 million.

Note 17. Income Taxes

For the three-month period ended September 27, 2008 the income taxes provision of $0.4 million was the result of aggregate charges for potential tax exposure of certain foreign jurisdictions of $0.2 million and $0.1 million relating to a tax exposure associated with the consolidation of duplicate foreign entities. The tax liability associated with the consolidation of duplicate foreign entities was offset by the utilization of net operating losses generated by Accent Optical Technologies prior to the merger with Nanometrics. In accordance with SFAS 109, the benefit derived from the utilization of the pre-acquisition net operating losses is recorded as a reduction of the acquired Accent intangible assets rather than a reduction of the related tax expense. For the nine-month period ended September 27, 2008 the income taxes provision of $0.5 million was the result of the aggregate charges for potential tax exposure of certain foreign jurisdictions of $0.6 million and $0.1 million relating to a tax exposure associated with the consolidation of duplicate foreign entities, partially offset by a tax benefit in a certain foreign jurisdiction where sufficient deferred tax liabilities exist to allow for benefiting the operating loss of $0.2 million, and reduction of a tax contingency of $0.1 million due to the expiration of local statues.

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The income taxes provision of $0.1 million for the three-month period ended September 29, 2007 was the result of foreign taxes of $0.2 million offset by $0.1 million of tax benefit in a certain foreign jurisdiction where sufficient deferred tax liabilities exist to allow for benefiting the operating loss.

Note 18. Contingencies

In August 2005, KLA-Tencor Corporation (“KLA”) filed a complaint against the Company in the United States District Court for the Northern District of California. The complaint alleges that certain of the Company’s products infringe two of KLA’s patents. On January 30, 2006, KLA added a third patent to their claim. The complaint seeks a preliminary and permanent injunction against the sale of these products as well as the recovery of monetary damages and attorneys’ fees. As part of its defense, the Company has filed a request for re-examination of two of the allegedly infringed KLA patents with the U.S. Patent & Trademark Office (“PTO”). In March 2006, the Company filed a motion for and was granted a stay in the patent litigation case until such re-examination is completed. On July 28, 2008, the PTO issued a Notice of Intent to issue a Reexamination Certificate for one of the KLA patents. The other two patent reexaminations remain pending. In all three of the reexamination proceedings, the PTO has issued Office Actions rejecting numerous claims and KLA has amended the claims in response.

Note 19. Geographic and Significant Customer Information

The Company has one operating segment, as defined in SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information”. The Company’s operating segment is the sale, design, manufacture, marketing and support of thin film, optical critical dimension and overlay dimension metrology systems. The following table summarizes total net revenues and long-lived assets (excluding intangible assets) attributed to significant countries (in thousands):

	Three-Months Ended				Nine-Months Ended
	September 27, 2008		September 29, 2007		September 27, 2008		September 29, 2007
Total net revenues:
United States	$	7,851	$	9,413	$	23,769	$	20,790
Japan		6,966		12,970		24,880		31,718
South Korea		3,048		5,440		13,043		28,859
Taiwan		2,498		829		5,307		7,531
China		132		5,840		7,115		10,307
Europe		2,142		2,897		3,799		12,374
All other		500		1,258		3,712		1,518
Total net revenues*	$	23,137	$	38,647	$	81,626	$	113,097

* Net revenues are attributed to countries based on the deployment and service locations of systems.

	September 27, 2008		December 29, 2007
Long lived assets
United States	$	35,879	$	37,767
Japan		1,084		1,165
South Korea		4,534		5,589
Taiwan		144		158
Europe		2,356		1,545
Total long lived assets**	$	43,997	$	46,224

** Long-lived assets include tangible assets only.

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The following customers accounted for 10% or more of total accounts receivable as of:

	September 27, 2008		December 29, 2007
Samsung	***		14.1	%
Toshiba	18.9	%	***

***  The customer accounted for less than 10% of total accounts receivable.

The following customers accounted for 10% or more of total revenue:

	Three-Months Ended				Nine-Months Ended
	September 27, 2008		September 29, 2007		September 27, 2008		September 29, 2007
Samsung Electronics Co. Ltd.	****		11.40	%	14.2	%	16.30	%
Hynix	****		****		****		12.70	%
Toshiba	22.1	%	11.10	%	12.0	%	****

****  The customer accounted for less than 10% of revenue during the period.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The statements contained in this document that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding our business in future periods. We may identify these statements by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” and other similar expressions. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements, except as may otherwise be required by law.

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain risk factors, including those set forth in Part II Item 1A “Risk Factors” and elsewhere in this document. In evaluating our business, current and prospective investors should carefully consider these factors in addition to the other information set forth in this document. We believe that it is important to communicate our expectations to our investors. However, there may be events in the future that we are not able to predict accurately or over which we have no control. You should be aware that the occurrence of the events described in such risk factors and elsewhere in this report could materially and adversely affect our business, operating results and financial condition. While management believes that the discussion and analysis in this report is adequate for a fair presentation of the information presented, we recommend that you read this discussion and analysis in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 29, 2007, which were included in our 2007 Annual Report on Form 10-K filed with the Securities Exchange Commission on March 13, 2008 and amended on April 25, 2008.

Overview

The semiconductor industry is cyclical in nature and has historically experienced periodic downturns and upturns. Today’s leading indicators of changes in customer investment patterns may not be any more reliable than in prior years. Demand for our equipment can vary significantly from period to period as a result of various factors, requirements, and our ability to develop, acquire, and market competitive products. For these and other reasons, our current results of operations may not necessarily be indicative of future operating results.

We are an innovator in the field of metrology systems for the semiconductor industry. Our systems are designed to precisely monitor film thickness and critical dimensions that are necessary to control the manufacturing process and provide increased production yields and performance.

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Capital expenditures by manufacturers of semiconductors and their suppliers are critical to our success. The demand by these manufacturers and suppliers is driven by the expected market demand for new products and new applications. The increasing complexity of the 300mm manufacturing processes for semiconductors is an important factor in the demand for our innovative metrology systems. The incorporation of smaller features sizes, copper interconnects technology and optical critical dimension technology is expected to result in increased demand. Our strategy is to continue to innovate organically and to evaluate strategic acquisitions in order to address business challenges and opportunities.

Our revenues are primarily derived from product sales, which include sales of accessories, but are also derived from customer service for the installed base of our products. In the year ended December 29, 2007, we derived 86.2% of our total net revenues from product sales and 13.8% of our total net revenues from services.

Important Themes and Significant Trends

The semiconductor equipment industry is characterized by cyclical growth. Changing trends in the semiconductor industry are increasing the need for metrology as a major component of manufacturing systems. These trends include:

• Incorporation of Optical Critical Dimension Metrology in the Patterning Process. Our customers use photolithographic processes to create patterns on wafers. Critical dimensions must be carefully controlled during this process. Our proprietary optical critical dimension systems can provide the critical process control of these circuit dimensions that is necessary for successful manufacturing of these state of the art devices.

• Copper Interconnect Technology. The need for ever increasing device circuit speed coupled with lower power consumption has pushed semiconductor device manufacturers to begin the replacement of the subtractive aluminum interconnect process with copper damascene technology. This new copper processing technology has driven the need for new metrology techniques such as non-destructive laser profiling and the use of optical critical dimension (OCD) technology for control of the copper process.

• Incorporation of 65nm and 45nm Feature Sizes. In an effort to reduce costs and increase device performance, semiconductor manufacturers are decreasing both the die size and feature size. Monitoring the increased tolerance requirements on smaller features sizes requires increased use of metrology systems. Our thin film and critical dimension metrology systems are well suited and are being adopted for these next generation processes.

• Reduced Number of Customers. Because of the escalating cost of 300mm manufacturing facilities, fewer semiconductor manufacturers can afford the significant investment in these next generation facilities. Therefore, fewer opportunities for semiconductor equipment companies exist. Given that the available number of potential customers is decreasing, previous customer relationships, product positioning and critical mass take on greater importance.

• Adoption of New Types of Thin Film Materials. Manufacturers are adopting new processes and technologies that increase the importance and utilization of thin film metrology systems. To achieve greater semiconductor device speed, manufacturers are utilizing copper and new, low dielectric constant (low k) insulating materials. Our advanced metrology solutions are required in the manufacturing process to characterize these materials.

• Need for Improved Process Control to Drive Process Efficiencies. Competitive forces influencing semiconductor device manufacturers, such as price-cutting and shorter product life cycles, place pressure on manufacturers to rapidly achieve production efficiency. Device manufacturers are using our integrated and standalone metrology systems throughout the fab to ensure that manufacturing processes scale rapidly, are accurate and can be repeated on a consistent basis.

Critical Accounting Policies

The preparation of our financial statements conforms to accounting principles generally accepted in the United States of America, which requires management to make estimates and judgments in applying our accounting policies that have an important impact on our reported amounts of assets, liabilities, revenue, expenses and related disclosures at the date of our financial statements. On an on-going basis, management evaluates its estimates including those related to bad debts, inventory valuations, warranty obligations and income taxes. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from management’s estimates. We believe that the application of the following accounting policies requires significant judgments and estimates on the part of management. For a summary of all of our accounting policies, including those discussed below, see Note 1 to The Consolidated Financial Statements included in our 2007 Annual Report on Form 10-K filed with the SEC on March 13, 2008 and amended on April 25, 2008.

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Revenue Recognition – We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the sales price is fixed or determinable, and collectibility is reasonably assured. Product revenue includes hardware and also software that is incidental to the products. For product sales to existing customers, revenue recognition generally occurs at the time of shipment, as our terms are FOB shipping point, if we have met defined customer acceptance experience levels with both the customer and the specific type of equipment. All other product revenue is recognized upon customer acceptance including deemed acceptances. In Japan, where risk of loss and title transfers to the customer upon customer technical acceptance, our policy is that revenue is recognized upon customer technical acceptance.

All of our products are assembled prior to shipment to our customers. We often perform limited installation for our customers; however such installation is inconsequential and perfunctory as it may also be performed by third parties. Revenue related to spare parts sales is recognized generally upon shipment and is included as part of service revenue. Service revenue also includes service contracts and non-warranty, billable repairs of systems. Whereas service revenue related to service contracts is recognized ratably over the period under contract, service revenue related to billable repairs of systems is recognized as services are performed. On occasion, customers request a warranty period longer than our standard 12 month warranty. In those instances where extended warranty services are separately quoted to the customer, we follow the guidance of Financial Accounting Standards Board Technical Bulletin 90-1, “Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts,” associated revenue is deferred and recognized to income ratably over the term of the contract. Unearned maintenance and service contract revenue is included in deferred revenue. Furthermore, generally we do not provide our customers with any return rights. Service contracts may be purchased by the customer when the warranty period expires.

In limited situations we have multiple deliverables in our customer arrangements. Those situations arise with the sale of repair services and parts together. Revenues on such sales are recognized when both the services and parts have been delivered. We also provide technical support to our customers as part of our warranty program. Upon recognition of product revenue, a liability is recorded for anticipated warranty costs.

Allowance for Doubtful Accounts – We maintain allowances for estimated losses resulting from the inability of our customers to make required payments. Credit limits are established through a process of reviewing the financial history and stability of our customers. Where appropriate and available, we obtain credit rating reports and financial statements of customers when determining or modifying their credit limits. We regularly evaluate the collectibility of our trade receivable balances based on a combination of factors such as the length of time the receivables are past due, customary payment practices in the respective geographies and our historical collection experience with customers. We believe that our allowance for doubtful accounts reflects our risk associated with smaller rather than larger customers and that our reported allowances are adequate. If however, the financial conditions of customers were to deteriorate, resulting in their inability to make payments, we would assess the necessity to record additional allowances which would result in additional general and administrative expenses being recorded for the period in which such determination was made.

Inventories – We are exposed to a number of economic and industry factors that could result in portions of our inventory becoming either obsolete or in excess of anticipated usage, or saleable only for amounts that are less than their carrying amounts. These factors include, but are not limited to, technological changes in our market, our ability to meet changing customer requirements, competitive pressures in products and prices, and the availability of key components from our suppliers. We have established inventory reserves when conditions exist that suggest that our inventory may be in excess of anticipated demand or is obsolete based upon our assumptions about future demand for our products and market conditions. We regularly evaluate our ability to realize the value of our inventory based on a combination of factors including the following: historical usage rates, forecasted sales of usage, product end-of-life dates, estimated current and future market values and new product introductions. For demonstration inventory, we also consider the age of the inventory and potential cost to refurbish the inventory prior to sale. When recorded, our reserves are intended to reduce the carrying value of our inventory to its net realizable value. If actual demand for our products deteriorates, or market conditions are less favorable than those that we project, additional reserves may be required. Inventories are stated at the lower of cost, using the first-in, first-out method, or market value.

Inventories – delivered systems –We reflect the cost of systems that were invoiced upon shipment but deferred for revenue recognition purposes separate from our inventory held for sale as “Inventories – delivered systems”.

Product Warranties – We sell the majority of our products with a twelve-month repair or replacement warranty from the date of acceptance which generally represents the date of shipment. We provide an accrual for estimated future warranty costs based upon the historical relationship of warranty costs to the cost of products sold. The estimated future warranty

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obligations related to product sales are reported in the period in which the related revenue is recognized. The estimated future warranty obligations are affected by the warranty periods, sales volumes, product failure rates, material usage, labor and replacement costs incurred in correcting a product failure. If actual product failure rates, material usage, labor or replacement costs differ from our estimates, revisions to the estimated warranty obligations would be required. For new product introductions where limited or no historical information exists, we may use warranty information from other previous product introductions to guide us in estimating our warranty accrual. The warranty accrual represents the best estimate of the amount necessary to settle future and existing claims on products sold as of the balance sheet date. We periodically assess the adequacy of our recorded warranty reserve and adjust the amounts in accordance with changes in these factors.

Goodwill and Intangible Assets – Goodwill is initially recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Under Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), intangible assets with finite lives are amortized over their useful lives while goodwill and indefinite lived assets are not amortized but tested annually for impairment. Our impairment review process is completed as of the last day of November of each year or whenever events or circumstances occur which indicate that an impairment might have occurred. SFAS 142 provides for a two-step approach to determining whether and by how much goodwill has been impaired. The first step requires a comparison of the fair value of Nanometrics (reporting unit) to its net book value. If the fair value is greater, then no impairment is deemed to have occurred. If the fair value is less, then the second step must be performed to determine the amount, if any, of actual impairment. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment. In estimating the fair value of Nanometrics, we made estimates and judgments about future revenues and cash flows for each reporting unit. To determine the fair value, our review process includes the income method and is based on a discounted future cash flow approach that uses estimates including the following for each reporting unit: revenue, based on assumed market growth rates and our assumed market share; estimated costs; and appropriate discount rates based on the particular business’s weighted average cost of capital. Our estimates of market segment growth, our market segment share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates we are using to manage the underlying businesses. Our business consists of both established and emerging technologies and our forecasts for emerging technologies are based upon internal estimates and external sources rather than historical information. We also considered our market capitalization on the dates of our impairment tests in determining the fair value of the respective businesses. We completed the first step and have determined that our fair value at June 28, 2008 exceeded our net book value on that date.

In accordance with SFAS 142, we concluded that events had occurred and circumstances had changed during the third quarter of 2008 which might indicate the existence of impairment indicators including a significant decline in our stock price and continued deterioration in the semiconductor equipment market and related impact on revenue forecasts of each reporting unit. Consistent with our approach of our annual impairment testing, in assessing the fair value of the reporting unit, we considered both the market approach and income approach. Under the market approach, the fair value of the reporting unit is based on quoted market prices and the number of shares outstanding of our common stock. Under the income approach, the fair value of the reporting unit is based on the present value of estimated future cash flows. We determined that the fair value of its reporting units was less than the net book value of the net assets of each reporting unit and accordingly, we performed step two of the impairment test.

In step two of the impairment test, we determined the implied fair value of the goodwill and compared it to the carrying value of the goodwill. With the assistance of a third party valuation firm, we allocated the fair value of the reporting units to all of its assets and liabilities as if the reporting unit had been acquired in a business combination and the fair value of the reporting units was the price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amount assigned to its assets and liabilities is the implied fair value of goodwill. Our step two analysis resulted in no implied fair value of goodwill, and therefore, we recognized an impairment charge of $54.0 million in the third quarter of 2008, representing a write-off of the entire amount of our previously recorded goodwill.

Income Tax Assets and Liabilities – We account for income taxes based on SFAS 109, “Accounting for Income Taxes”, whereby deferred tax assets and liabilities must be recognized using enacted tax rates for the effect of temporary differences between the book and tax accounting for assets and liabilities. Also, deferred tax assets must be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized in the future. We evaluate the deferred tax assets on a quarterly basis to determine whether or not a valuation allowance is appropriate. Factors used in this determination include future expected income and the underlying asset or liability which generated the temporary tax difference. Our income tax provision is primarily impacted by federal statutory rates, state and foreign income taxes and changes in our valuation allowance.

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Stock-Based Compensation – Upon adoption of SFAS 123(R), “Share based payment”, on January 1, 2007, we began estimating the value of employee stock options on the date of grant using the Black-Scholes model. Prior to the adoption of SFAS 123(R), the value of each employee stock option was estimated on the date of grant using the Black-Scholes model for the purpose of the pro forma financial disclosure in accordance with SFAS 123. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. The expected term of options granted is calculated based on the simplified method allowed by Staff Accounting Bulletin 107. The expected volatility is based on the historical volatility of our stock price.

Restructuring Charge - During each of the three-month periods ended March 29, 2008 and September 27, 2008, we implemented a restructuring program based on our business strategy and recorded a significant accrual in connection with the restructuring program. In connection with the plan we have recorded estimated expenses for severance and other costs. In accordance with SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities”, generally costs associated with restructuring activities have been recognized when they are incurred rather than the date of a commitment to an exit or disposal plan. In addition post-employment benefits accrued for workforce reductions related to restructuring activities are accounted for under SFAS 112, “Employer’s Accounting Post-Employment Benefits”. A liability for post-employment benefits is recorded when payment is probable, the amount is reasonably estimable, and the obligation relates to rights that have vested or accumulated. Given the significance and complexity of restructuring activities, and the timing of the execution of such activities, the restructuring process involves periodic reassessments of the estimates made at the time the original decisions were made, including evaluating market conditions for expected disposals of assets and vacancy of space. Although we believe that these estimates accurately reflect the costs of the restructuring programs, actual results may vary or differ, thereby requiring us to record additional provisions or reverse a portion of such provisions.

Recent Accounting Pronouncements

See Note 2 of the Unaudited Consolidated Financial Statements for a description of recent accounting pronouncements, including the respective dates of adoption and effects on results of operations and financial condition.

Results of Operations

Periods ended September 27, 2008 and September 29, 2007

Total net revenues. Our net revenues were comprised of the following categories:

	Three-Months Ended									Nine-Months Ended
	September 27, 2008		September 29, 2007		Change			Percentage Change		September 27, 2008		September 29, 2007		Change			Percentage Change
Automated systems	$	9,163	$	25,824	$	(16,661	)	(64.5	%)	$	47,654	$	75,237	$	(27,583	)	(36.7	%)
Integrated systems		7,148		7,482		(334	)	(4.5	%)		15,090		23,327		(8,237	)	(35.3	%)
Total product revenue		16,311		33,306		(16,995	)	(51.0	%)		62,744		98,564		(35,820	)	(36.3	%)
Service		6,826		5,341		1,485		27.8	%		18,882		14,533		4,349		29.9	%
Total net revenues	$	23,137	$	38,647	$	(15,510	)	(40.1	%)	$	81,626	$	113,097	$	(31,471	)	(27.8	%)

For the three- and nine-month periods ended September 27, 2008, net revenues from automated systems decreased by $16.7 million and $27.6 million, respectively, from the comparable periods of 2007 and net revenues from our integrated systems decreased $0.3 million and $8.2 million, respectively, from the comparable periods of 2007. The overall decrease in product revenue of 51.0% and 36.3%, respectively, is reflective of the ongoing general economic environment in the semiconductor equipment manufacturing sector.

Service revenue increased by $1.5 million and $4.3 million, respectively, during the three- and nine-month periods ended September 27, 2008 over the comparable periods of 2007 due to a significant increase of in-the-field tool upgrades and an increased focus on billable service and spare parts.

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Gross margins. Our gross margin breakdown was as follows (in percent):

	Three-Months Ended				Nine-Months Ended
	September 27, 2008		September 29, 2007		September 27, 2008		September 29, 2007
Products	50.0	%	49.6	%	50.6	%	48.6	%
Services	30.0	%	10.3	%	23.0	%	(6.4	)%

The product gross margin for the three- and nine-month periods ended September 27, 2008 increased slightly from the comparable periods of 2007 due to reductions in our cost structure such as higher product reliability and reduction of manufacturing costs from the completion of the integration of our 2006 acquisitions of Accent and Soluris including the closure of a facility in Concord, Massachusetts and out-sourcing the manufacturing of several of our products to contract manufactures offset by lower utilization of our manufacturing facilities due to lower revenues. In addition, the Company reduced its estimate of integration fees on certain products sold to a customer in Japan by $0.3 million and $0.7 million during the three- and nine-month periods, respectively, ended September 27, 2008.

The gross margin for our services line of business increased to 30.0% and 23.0%, respectively, for the three- and nine-month periods ended September 27, 2008 as compared to gross margins of 10.3% and a negative 6.4% for the comparable periods of 2007. The increase in gross margin reflects a higher level of in-the-field tool upgrades which provide favorable margins, increased efforts on billable service and spare parts sales and our focus on controlling expenses including personnel, personnel related expenses and material costs as compared to 2007.

Operating expenses. Our operating expenses were comprised of the following (in thousands):

	Three-Months Ended										Nine-Months Ended
	September 27, 2008		September 29, 2007			Change					September 27, 2008		September 29, 2007			Change
Research and development	$	4,430	$	4,661		$	(231	)	(5.0	)%	$	13,107	$	13,986		$	(879	)	(6.3	)%
Selling		4,280		4,603			(323	)	(7.0	)%		13,963		14,636			(673	)	(4.6	)%
General and administrative		4,935		4,783			152		3.2	%		15,761		16,538			(777	)	(4.7	)%
Amortization of intangible assets		600		1,285			(685	)	(53.3	)%		3,215		4,497			(1,282	)	(28.5	)%
Restructuring charge		655		2,128			(1,473	)	(69.2	)%		1,525		2,128			(603	)	(28.3	)%
Asset impairment		55,332		—			55,332		100.0	%		68,545		—			68,545		100.0	%
Gain on sale of assets		—		(2,100	)		2,100		100.0	%		—		(2,100	)		2,100		100.0	%
Total operating expenses	$	70,232	$	15,360		$	54,872		(357.2	)%	$	116,116	$	49,685		$	66,431		133.7	%

Research and development. Research and development expenses decreased by $0.2 million and $0.9 million for the three- and nine-month periods ended September 27, 2008, respectively, over the comparable periods in 2007 due to lower product development expenses such as materials and outside consulting services of $0.7 million and $0.3 million respectively.

Selling. Selling expenses decreased by $0.3 million and $0.7 million, respectively, for the three- and nine-month periods ended September 27, 2008 as compared to the corresponding periods of 2007 due primarily to lower personnel and personnel related expenses.

General and administrative. General and administrative expenses increased slightly for the three-month period ended September 27, 2008 with the comparable period in 2007. The increase was due primarily to termination charges of a certain senior executive. For the nine-month period ended September 27, 2008 general and administrative expenses decreased $0.8 million from the comparable period in 2007. The decrease was primarily due to lower legal expenses of $1.1 million as we settled the patent litigation with Nova Measuring Instruments Ltd (“Nova”) in April 2007 and also reductions of $0.3 million of depreciation expense and $0.2 million of regulatory and compliance costs offset by higher stock-based compensation of $0.5 million and various other expenses of $0.3 million.

Amortization of intangible assets. For the three-and nine-month periods ended September 27, 2008 the decrease in amortization of intangible assets of $0.7 million and $1.3 million over the comparable periods of 2007 reflects lower amortization expense due to the $11.8 million asset impairment during the second quarter of 2008, discussed below and to the backlog intangible asset acquired with the Accent acquisition, which was fully amortized by the second quarter of 2007.

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Restructuring charge. During the first and third quarters of 2008, the Company reduced its global work force by approximately 30 and 34 employees, respectively. This reduction affected employees in each of our locations worldwide and is aimed at reducing our operating expenses through improving our variable to fixed cost ratio and effective consolidation and elimination of overlap within our business entities. We recorded a charge of $0.9 million and $0.7 million, respectively, in the first and third quarters of fiscal 2008.

During the third quarter of 2007, the Company announced it would close its Milpitas, California machine shop and plating facility as part of its strategy to reverse its manufacturing vertical integration and lower its breakeven point. In conjunction with this closure, we recorded a restructuring charge in an amount of $2.1 million consisting of $1.9 million write-down of property, plant and equipment, $0.1 million for professional fees and $0.1 million for severance payments.

Asset impairment.

Goodwill: During the three-month period ended September 27, 2008 we concluded that events had occurred and circumstances had changed which might indicate the existence of impairment indicators including a significant decline in our stock price and continued deterioration in the semiconductor equipment market and related impact on revenue forecasts of each reporting unit. In accordance with SFAS 142 and consistent with our approach of our annual impairment testing, in assessing the fair value of the reporting unit, we considered both the market approach and income approach. Under the market approach, the fair value of the reporting unit is based on quoted market prices and the number of shares outstanding of our common stock. Under the income approach, the fair value of the reporting unit is based on the present value of estimated future cash flows. We determined that the fair value of our reporting units was less than the net book value of the net assets of each reporting unit and accordingly, we performed step two of the impairment test. In step two of the impairment test, we determined the implied fair value of the goodwill and compared it to the carrying value of the goodwill. With the assistance of a third party valuation firm, we allocated the fair value of the reporting units to all of its assets and liabilities as if the reporting unit had been acquired in a business combination and the fair value of the reporting units was the price paid to acquire the reporting units. The excess of the fair value of the reporting unit over the amount assigned to the assets and liabilities is the implied fair value of goodwill. Our step two analysis resulted in no implied fair value of goodwill, and therefore, we recognized an impairment charge of $54.0 million in the third quarter of 2008, representing a write-off of the entire amount of our previously recorded goodwill.

Intangible Assets: Also, during the three-month period ended September 27, 2008 we performed an analysis in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets”, of our long-lived assets including intangible assets and other long-lived assets where cash flows could be identified with a specific group of assets. Due to the continuing deterioration in the semiconductor equipment market, our forecasted revenues have declined for certain product lines relating to specific intangible assets acquired in the 2006 acquisition of Accent Optical Technologies, Inc. We performed an analysis in accordance with SFAS 144 of our long-lived intangible assets where cash flows could be identified with a specific group of assets. We performed step one of the impairment test for the specified intangible assets and have determined that at September 27, 2008, the net book value exceeded the undiscounted future cash flows. Accordingly, we completed step two of the impairment analysis utilizing a present value technique to estimate the fair value of the impaired assets. As a result of this analysis, an impairment charge of $1.4 million was recorded in the third quarter of 2008 to reflect certain brand names and developed technology intangible assets at their fair value.

For the three month period ended June 28, 2008, we perform an analysis in accordance with SFAS 144 of our long-lived intangible assets where cash flows could be identified with a specific group of assets. Due to changes in the forecasts, relating to specific intangible assets acquired in our 2006 acquisitions, caused by management’s decision to focus our resources on new generation products, and changes in the forecasts relating to the machine shop, we performed an impairment analysis in accordance with SFAS 144. SFAS 144 provides for a two-step approach to determining whether and by how much a long-lived asset has been impaired. The first step requires a comparison of the future undiscounted cash flows of the asset to its net book value. If undiscounted future cash flows are greater, then no impairment is deemed to have occurred. If the undiscounted future cash flows are less, then the second step must be performed to determine the amount, if any, of actual impairment. We performed step one impairment test for certain of the long-lived asset and have determined that at June 28, 2008, the net book value exceeded the undiscounted future cash flows for certain intangible assets as well as for assets associated with our machine shop and plating facility which was subcontracted in the third fiscal quarter of 2007. The initial projected future cash flows from subcontracting this facility have been significantly reduced due to operational limitations. Accordingly, we completed step two of the impairment analysis utilizing a present value technique to estimate the fair value of the impaired assets. As a result of this analysis, impairment charges of $11.8 million and $1.5 million, respectively, were recorded in the second quarter of 2008 to reflect certain customer relationships and developed technology intangible assets and machine shop related assets at their fair value.

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Gain on the sale of assets. In August 2007 we entered into a contract to sell a parcel of land and building in Japan and realized a gain on the sale of $1.1 million. In addition, the sale of a condominium in California was consummated in July 2007 and we realized a gain of $0.2 million in the third quarter of 2007. We also sold other non-strategic assets during the third quarter of 2007 realizing a gain of $0.8 million.

Other income (expense). Our net other income (expense) consisted of the following categories (in thousands):

	Three-Months Ended											Nine-Months Ended
	September 27, 2008			September 29, 2007			Change					September 27, 2008			September 29, 2007			Change
Interest income	$	24		$	69		$	(45	)	(65.2	)%	$	156		$	121		$	35		28.9	%
Interest expense		(240	)		(56	)		(184	)	(328.6	)%		(343	)		(141	)		(202	)	(143.3	)%
Other income (loss)		142			382			(240	)	(62.8	)%		564			(40	)		604		1,510.0	%
Total other income (expenses)	$	(74	)	$	395		$	(469	)	(118.7	)%	$	377		$	(60	)	$	437		728.3	%

For the three-month period ended September 27, 2008 we incurred higher interest expense due to the issuance of debt obligations during the quarter. For the three- and nine-month periods ended September 27, 2008, we incurred more favorable foreign exchange gains and losses due to exchange rate fluctuations associated with our extensive inter-company balances between our various global entities over the comparable periods of 2007.

Provision for income taxes. For the three-month period ended September 27, 2008 the income taxes provision of $0.4 million was the result of aggregate charges for potential tax exposure of certain foreign jurisdictions of $0.2 million and $0.1 million relating to a tax exposure associated with the consolidation of duplicate foreign entities. For the nine-month period ended September 27, 2008 the income taxes provision of $0.5 million was the result of the aggregate charges for potential tax exposure of certain foreign jurisdictions of $0.6 million and $0.1 million relating to a tax exposure associated with the consolidation of duplicate foreign entities, partially offset by a tax benefit in a certain foreign jurisdiction where sufficient deferred tax liabilities exist to allow for benefiting the operating loss of $0.2 million, and reduction of a tax contingency of $0.1 million due to the expiration of local statues.

The income taxes provision of $0.1 million for the three-month period ended September 29, 2007 was the result of foreign taxes of $0.2 million offset by $0.1 million of tax benefit in a certain foreign jurisdiction where sufficient deferred tax liabilities exist to allow for benefiting the operating loss.

Liquidity and Capital Resources

At September 27, 2008, our cash and cash equivalents totaled $21.8 million compared to $14.9 million as of December 29, 2007. At September 27, 2008, we had working capital of $58.3 million compared to $57.1 million at December 29, 2007. The current ratio at September 27, 2008 was 3.7 to 1.

Operating activities provided cash of $1.8 million for the nine-month period ended September 27, 2008 resulting from certain non-cash charges including $68.5 million of impairment charges for long-lived assets, $6.1 million associated with amortization and depreciation, $3.1 million in stock-based compensation, and increases in net working capital of $4.5 million partially offset by our net loss of $80.1 million. Operating activities provided cash of $2.9 million for the nine-month period ended September 29, 2007 resulting from certain non-cash charges including $7.0 million associated with amortization and depreciation and $2.7 million in stock-based compensation offset by increases in net working capital of $3.9 million and our net loss of $2.7 million. For the nine-months ended September 29, 2007, cash provided from the reduction of working capital were primarily driven by reduction of inventory levels of $4.6 million and increases in accounts payable and accrued liabilities of $5.7 million offset by increases in accounts receivable of $8.9 million due to higher revenue and reductions in deferred revenue and product margin of $4.3 million.

Investing activities for the nine-month period ended September 27, 2008 used cash of $6.1 million related to cash outlays of $3.4 million of our acquisition of Tevet Process Control Technologies, Ltd. (“Tevet”) and capital equipment acquisitions of $2.8 million. Investing activities for the nine-month period ended September 29, 2007 provided cash of $2.8 million. We received sales proceeds of $3.9 million from the sale of assets (see preceding discussion for “Gain on sale of assets”) offset by $1.0 million for purchases of property, plant and equipment.

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For the nine-month period ended September 27, 2008, financing activities provided cash of $12.1 million. Proceeds from the issuance of $13.5 million of debt obligation, as more fully described below, and $0.6 million from the sale of stock from employee stock plans and purchase plan were offset by $1.8 million used for the repurchase of our common stock and $0.1 million for debt payments. For the nine-month period ended September 29, 2007, financing activities provided cash of $1.4 million due to the sale of stock under employee stock option and purchase plans of $3.1 million offset by the repayment of debt of $1.5 million and repurchases of stock of $0.2 million.

In July 2008, we entered into a lending facility in the principal amount of $13.5 million maturing in July 2018. All borrowings under this facility bear a fixed interest for five years at a per annum rate equal to 7.18% whereupon the interest rate will be reset to a fixed rate for the following five years equal to the weekly average yield of five year U.S. dollar interest rate swaps in effect plus 3.03%. The loan is collateralized by a lien on the building and land comprising our principal offices in Milpitas California. We will use the proceeds of these borrowing for general corporate purposes or for future acquisitions or expansion of our business.

In February 2007, we entered into a two-year agreement for a revolving line of credit facility in a maximum principal amount of up to $15 million. The instrument governing the facility includes certain financial covenants regarding net tangible worth. All borrowings under this credit line bear interest, at our election, at a per annum rate equal to the bank’s prime rate or at the Libor rate plus 2.25%. The revolving line of credit agreement includes a provision for the issuance of commercial or standby letters of credit by the bank on our behalf. The value of all letters of credit outstanding reduces the total line of credit available. The revolving line of credit is collateralized by a blanket lien on all of our domestic assets excluding intellectual property and real estate. We may use the proceeds of any future borrowing under this credit facility for general corporate purposes or for future acquisitions or expansion of our business. Renewal of our revolving line of credit facility is due in February 2009. While we anticipate we will renew the line of credit, the present economic conditions in the banking and financing industry are very volatile and uncertain. We may be unable to renew the line of credit under the same general terms and conditions under which we presently operate.

We have evaluated and will continue to evaluate the acquisition of products, technologies or businesses that are complementary to our business. These activities may result in product and business investments, which may affect our cash position and working capital balances. Some of these activities might require significant cash outlays. For example, in the third quarter of 2007, our Board of Directors authorized a stock repurchase program of up to $4 million, of which, there remains $1.4 million available for future repurchases. However, we believe our working capital including cash and cash equivalents; will be sufficient to meet our needs through at least the next twelve months. However, we may require additional cash to fund acquisitions or investment opportunities or other events that may arise in the future. In these instances, we may seek to raise such additional funds through public or private equity or debt financings or from other sources. We may not be able to obtain adequate or favorable financing at that time. Any financing we obtain may dilute ownership interests and any debt financing could contain covenants that impose limitations on the conduct of our business.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk does not differ materially from that discussed in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 filed with the SEC on March 13, 2008 and amended on April 25, 2008. However, we cannot give any assurance as to the effect that future changes in interest rates or foreign currency rates will have on our consolidated financial position, results of operations or cash flows.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management evaluated, with the participation of our Chief Executive Officer, Timothy J. Stultz, and our Chief Financial Officer, Bruce A. Crawford, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. As of September 27, 2008 our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were effective to ensure that information that we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 were recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

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Changes in Internal Control over Financial Reporting

As disclosed in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 filed with the SEC on March 13, 2008 and amended on April 25, 2008, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, Gary C. Schaefer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 29, 2007. As a result of such evaluation, management identified a material weakness in our internal control over financial reporting as of December 29, 2007 related to our controls over international income tax accounting. Specifically, the Company’s process and procedures surrounding its accounting for international taxes were not effective as of December 29, 2007 in both design and operation, as the existing process and procedures failed to adequately and timely manage the international tax accounting process. As September 5, 2008, Mr. Schaefer resigned as Chief Financial Officer and was replaced by Mr. Crawford.

During our most recent fiscal quarter, we have taken the following steps to remediate the material weakness described above which we believe are necessary to address the issues associated with our material weakness over international income tax accounting, including implementing changes that are both organizational and process-focused to improve the design and operation of the controls. Such planned changes include:

• Initiation of a global transfer pricing study,

• Increased oversight and monitoring of accounting procedures and review of our international tax accounting and,

• Rationalizing and simplifying the tax structures of our foreign entities.

We are in the process of implementing the above mentioned changes as of the quarter ended September 27, 2008, and upon completion of the testing of our internal controls subsequent to this date, we will determine the operating effectiveness of the enhanced controls.

Other than as noted above, there were no changes in our internal control over financial reporting during the three-month period ended September 27, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In August 2005, KLA-Tencor Corporation, or KLA, filed a complaint against us in the United States District Court for the Northern District of California. The complaint alleges that certain of our products infringe two of KLA’s patents. On January 30, 2007, KLA added a third patent to their claim. The complaint seeks a preliminary and permanent injunction against the sale of these products as well as the recovery of monetary damages and attorneys’ fees. We do not believe that any of our products infringe the intellectual property of any third party and we intend to vigorously and aggressively defend ourselves in the litigation. As part of such defense, we have filed a request for re-examination of the three allegedly infringed KLA patents with the U.S. Patent & Trademark Office, or PTO. In March 2006, we filed a motion for and were granted a stay in the patent litigation case until such re-examination is completed. On July 28, 2008, the PTO issued a Notice of Intent to issue a Reexamination Certificate for one of the KLA patents. The other two patent reexaminations remain pending. In all three of the reexamination proceedings, the PTO has issued Office Actions rejecting numerous claims and KLA has amended the claims in response.

ITEM 1A. RISK FACTORS

A restated description of the risk factors associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risk factors included in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 filed with the SEC on March 13, 2008 and amended on April 25, 2008. The risks and uncertainties described below are not the only ones that we face. If any of the following risks actually occurs, our business, financial condition or operating results could be harmed. In such case, the trading price of our common stock could decline, and you could lose all or part of your investment.

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Risks Related to Our Business

Customer demand for our products is inelastic and has led to fluctuations in revenue from period to period and is expected to continue to do so.

Our operating results have varied significantly from period to period due to the inelastic nature of our products. The majority of our business depends upon the capital expenditures of semiconductor device and equipment manufacturers. These manufacturers’ capital expenditures, in turn, depend upon the current and anticipated market demand for semiconductors and products using semiconductors. The semiconductor industry has historically experienced periodic downturns. These downturns have often resulted in substantial decreases in the demand for semiconductor manufacturing equipment, including metrology systems. We have found that the resulting decrease in capital expenditures has typically been more pronounced than the downturn in semiconductor device industry revenues. We expect the inelastic nature of demand for our products, and therefore, our business, to continue in the foreseeable future.

We depend on OEM suppliers for sales of our integrated metrology systems, and the loss of our OEM suppliers as a customer could harm our business.

We believe that sales of integrated metrology systems will continue to be an important source of our revenues. Sales of our integrated metrology systems depend upon the ability of OEMs to sell semiconductor equipment products that include our metrology systems as components. If our OEMs are unable to sell such products, or if they choose to focus their attention on products that do not integrate our systems, our business could suffer. If we were to lose our OEMs as a customer for any reason, our ability to realize sales from integrated metrology systems would be significantly diminished, which would harm our business.

Efforts to restructure our operations and align our resources with market opportunities could disrupt our business and affect our results of operations.

Since 2007, we have taken steps, including reductions in force, facility closures, and internal reorganizations to reduce the size and cost of our operations and to better match our resources with our market opportunities. We may take similar steps in the future to improve efficiency and match our resources with market opportunities. Any such changes could be disruptive to our business and may result in the recording of accounting charges. These include inventory and technology-related write-offs, workforce reduction costs and charges relating to consolidation of excess facilities. If we are required to take a substantial charge related to any future restructuring activities, our results of operations would be adversely affected in the period in which we take such a charge.

If any of our systems fail to meet or exceed our internal quality specifications, we do not ship them until such time as they have met such specifications. If we experience significant delays or are unable to ship our products to our customers as a result of our internal processes, or for any other reason, our business and reputation may suffer.

Our products are complex and require technical expertise to design and manufacture properly. Various problems occasionally arise during the manufacturing process that may cause delays and/or impair product quality. We must actively monitor our manufacturing processes to ensure that our products meet our internal quality specifications. Any significant delays stemming from the failure of our products to meet or exceed our internal quality specifications, or for any other reasons, would delay our shipments. Shipment delays could harm our business and reputation in the industry.

If we deliver systems with defects, our credibility will be harmed, revenue from, and market acceptance of, our systems will decrease and we could expend significant capital and resources as a result of such defects.

Notwithstanding our internal quality specifications, our systems have sometimes contained errors, defects and bugs when introduced. If we deliver systems with errors, defects or bugs, our credibility and the market acceptance and sales of our systems would be harmed. Further, if our systems contain errors, defects or bugs, we may be required to expend significant capital and resources to alleviate such problems. Defects could also lead to product liability as a result of product liability lawsuits against us or against our customers. We have agreed to indemnify our customers in some circumstances against liability arising from defects in our systems. In the event of a successful product liability claim, we could be obligated to pay damages significantly in excess of our product liability insurance limits.

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Our largest customers account for a substantial portion of our revenue, and our revenue would materially decline if one or more of these customers were to purchase significantly fewer of our systems or if they delayed or cancelled a large order.

Historically, a significant portion of our revenues in each quarter and each year has been derived from sales to a relatively few customers, and we expect this trend to continue. There are only a limited number of large companies operating in the semiconductor industry. Accordingly, we expect that we will continue to depend on a small number of large customers for a significant portion of our revenues for the foreseeable future. If any of our key customers were to purchase significantly fewer systems, or if a large order were delayed or cancelled, our revenues could significantly decline.

The success of our product development efforts depends on our ability to anticipate market trends and the price, performance and functionality requirements of semiconductor device manufacturers. In order to anticipate these trends and ensure that critical development projects proceed in a coordinated manner, we must continue to collaborate closely with our customers. Our relationships with our customers provide us with access to valuable information regarding industry trends, which enables us to better plan our product development activities. If our current relationships with our large customers are impaired, or if we are unable to develop similar collaborative relationships with important customers in the future, our long-term ability to produce commercially successful systems could be adversely affected.

We have had significant management changes since the end of the last fiscal year and these changes may impact our ability to execute our business strategy in the near term. In general, our success depends to a significant extent on the performance of our senior management and on our ability to identify, hire and retain key management personnel.

In August 2007, our Chief Executive Officer joined the Company. Effective September 5, 2008 Gary Schaefer, resigned as our Chief Financial Officer and Vice President, Administration and was replaced, on an interim basis, by Bruce Crawford. While we are confident in the officers’ abilities to manage the Company, our business may be affected. Furthermore, we must be able to identify, hire and retain key personnel. Although we have employment agreements with certain key members of our senior management team, including Messrs. Stultz, and Crawford, these individuals or other key employees may still leave us. We do not have key person life insurance on any of our executives. In addition, to support our future growth, we will need to attract and retain additional qualified employees. Competition for such personnel in our industry is intense, and we may not be successful in attracting and retaining qualified employees. If we fail to attract, motivate and retain qualified senior management personnel, our business could be harmed and our ability to implement our strategy could be compromised.

Failure To achieve and maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 could have a material effect on our business.

As a publicly traded company, we are subject to rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires us to include an internal control report from management in our Annual Report on Form 10-K filed with the SEC on March 13, 2008 and amended April 25, 2008. The internal control report must include the following: (1) a statement of management’s responsibility for establishing and maintaining adequate internal control over financial reporting, (2) a statement identifying the framework used by management to conduct the required evaluation of the effectiveness of our internal control over financial reporting, (3) management’s assessment of the effectiveness of our internal control over financial reporting as of the end of each fiscal year, including a statement as to whether or not internal control over financial reporting is effective, and (4) a statement that our independent registered public accounting firm has issued an attestation report on management’s internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. Our assessment as of December 29, 2007 identified a material weakness in our internal controls over financial reporting, which also adversely impacted our disclosure controls and procedures. A material weakness results in a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. Since discovery of the material weakness, we have performed extensive additional work to obtain reasonable assurance regarding the reliability of our financial statements. Even with this additional work, however, there is a risk of errors not being prevented or detected. For additional information refer to Item 9A “Controls and Procedures in our Annual Report”.

Because of the material weakness referenced in the preceding paragraph, management has concluded that, as of December 29, 2007, our internal controls over financial reporting were not effective based on those criteria. This failure and any failure in the future to achieve and maintain effective internal controls over financial reporting and otherwise comply with the requirements of Section 404 could have a material adverse effect on our business. Such noncompliance could result in perceptions of our business among customers, suppliers, lenders, investors, securities analysts and others being adversely affected. We may not be able to complete our remediation plans designed to address the identified material weakness in our internal controls over financial reporting and continue to attract additional qualified accountants, and auditing and compliance professionals to assist in completing such plans and maintaining compliance programs.

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Restructuring of our operations may adversely affect our financial condition and operating results.

We have incurred expenses related to restructuring of our operations in the past, and we may incur additional restructuring expenses in the future. For example, in the first and third quarters of 2008, we undertook a restructuring that involved a reduction of our global workforce by approximately 30 and 34 employees, respectively, and that caused us to record restructuring and reorganization charges of $870,000 and $655,000, respectively.

Several factors could cause a restructuring to adversely affect our business, financial condition and results of operations. These include potential disruption of our operations, the development of our technology, our supply chain and other aspects of our business. Employee morale and productivity could also suffer and result in unintended employee attrition. Loss of sales, service and engineering talent, in particular, could damage our business. Any restructuring would require substantial management time and attention and may divert management from other important work. If we undertake further employee reductions or other restructuring activities, we will likely record restructuring and related expenses. Moreover, we could encounter delays in executing any restructuring plans, which could cause further disruption and additional unanticipated expense.

Our current and potential competitors have significantly greater resources than we do, and increased competition could impair sales of our products.

We operate in the highly competitive semiconductor industry and face competition from a number of companies, many of which have greater financial, engineering, manufacturing, marketing and customer support resources than we do. As a result, our competitors may be able to respond more quickly to new or emerging technologies or market developments by devoting greater resources to the development, promotion and sale of products, which could impair sales of our products. Moreover, there has been merger and acquisition activity among our competitors and potential competitors. These transactions by our competitors and potential competitors may provide them with a competitive advantage over us by enabling them to rapidly expand their product offerings and service capabilities to meet a broader range of customer needs. Many of our customers and potential customers in the semiconductor industry are large companies that require global support and service for their metrology systems. Some of our larger or more geographically diverse competitors might be better equipped to provide this global support.

Successful infringement claims by third parties could result in substantial damages, lost product sales and the loss of important intellectual property rights by us.

Our commercial success depends, in part, on our ability to avoid infringing or misappropriating patents or other proprietary rights owned by third parties. From time to time we may receive communications from third parties asserting that our metrology systems may contain design features which are claimed to infringe on their proprietary rights. For example, in August 2005, we were served with a complaint by KLA alleging that certain of our products infringe two of KLA’s patents, Patent No. 6,483,580 and Patent No. 6,590,656. In January 2006, KLA added Patent No. 6,611,330 to its claim. For additional information, refer to Part II, Item 1. Legal Proceedings. There can be no assurance that Nanometrics’ new or current products do not infringe any valid intellectual property rights. Even if our products do not infringe, we may be required to expend significant sums of money to defend against infringement claims, as in the KLA lawsuit described above, or to actively protect our intellectual property rights through litigation.

We obtain some of the components and subassemblies included in our systems from a single source or a limited group of suppliers, and the partial or complete loss of one of these suppliers could cause production delays and significant loss of revenue.

We rely on outside vendors to manufacture many components and subassemblies. Certain components, subassemblies and services necessary for the manufacture of our systems are obtained from a sole supplier or limited group of suppliers. We do not maintain any long-term supply agreements with any of our suppliers. We have entered into arrangements with J.A. Woollam Company for the purchase of the spectroscopic ellipsometer component incorporated in our advanced measurement systems. Our reliance on a sole or a limited group of suppliers involves several risks, including the following:

• we may be unable to obtain an adequate supply of required components;

• we have reduced control over pricing and the timely delivery of components and subassemblies; and

• our suppliers may be unable to develop technologically advanced products to support our growth and development of new systems.

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Some of our suppliers have relatively limited financial and other resources. Because the manufacturing of certain of these components and subassemblies involves extremely complex processes and requires long lead times, we may experience delays or shortages caused by our suppliers. If we were forced to seek alternative sources of supply or to manufacture such components or subassemblies internally, we could be forced to redesign our systems, which could cause production delays and prevent us from shipping our systems to customers on a timely basis. Any inability to obtain adequate deliveries from our suppliers, or any other circumstance that would restrict our ability to ship our products, could damage relationships with current and prospective customers, harm our business and result in significant loss of revenue.

Variations in the amount of time it takes for us to sell our systems may cause fluctuations in our operating results, which could cause our stock price to decline.

Variations in the length of our sales cycles could cause our revenues to fluctuate widely from period to period. Our customers generally take long periods of time to evaluate our metrology systems. We expend significant resources educating and providing information to our prospective customers regarding the uses and benefits of our systems. The length of time that it takes for us to complete a sale depends upon many factors, including:

• the efforts of our sales force and our independent sales representatives;

• the complexity of the customer’s metrology needs;

• the internal technical capabilities and sophistication of the customer;

• the customer’s budgetary constraints; and

• the quality and sophistication of the customer’s current processing equipment.

Because of the number of factors influencing the sales process, the period between our initial contact with a customer and the time at which we recognize revenue from that customer, if at all, varies widely. Our sales cycles, including the time it takes for us to build a product to customer specifications after receiving an order, typically range from three to nine months. Occasionally our sales cycles can be much longer, particularly with customers in Asia who may require longer evaluation periods. During the sales cycles, we commit substantial resources to our sales efforts in advance of receiving any revenue, and we may never receive any revenue from a customer despite our sales efforts.

If we do complete a sale, customers often purchase only one of our systems and then evaluate its performance for a lengthy period of time before purchasing additional systems. The purchases are generally made through purchase orders rather than through long-term contracts. The number of additional products that a customer purchases, if any, depends on many factors, including a customer’s capacity requirements. The period between a customer’s initial purchase and any subsequent purchases is unpredictable and can vary from three months to a year or longer. Variations in the length of this period could cause fluctuations in our operating results, which could adversely affect our stock price.

Relatively small fluctuations in our system sales volume may cause our operating results to vary significantly each quarter.

During any quarter, a significant portion of our revenue is derived from the sale of a relatively small number of systems. Our automated metrology systems range in price from approximately $200,000 to over $1,000,000 per system, our integrated metrology systems range in price from approximately $80,000 to $400,000 per system. Accordingly, a small change in the number or mix of systems that we sell could cause significant changes in our operating results.

We depend on orders that are received and shipped in the same quarter, and therefore our results of operations may be subject to significant variability from quarter to quarter.

Our net sales in any given quarter depend upon a combination of orders received in that quarter for shipment in that quarter and shipments from backlog. Our backlog at the beginning of each quarter does not include all systems sales needed to achieve expected revenues for that quarter. Consequently, we are dependent on obtaining orders for systems to be shipped in the same quarter that the order is received. Moreover, customers may reschedule shipments, and production difficulties could delay shipments. Accordingly, we have limited visibility into future product shipments, and our results of operations may be subject to significant variability from quarter to quarter.

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Because of the high cost of switching equipment vendors in our markets, it may be difficult for us to attract customers from our competitors even if our metrology systems are superior to theirs.

We believe that once a semiconductor customer has selected one vendor’s metrology system, the customer generally relies upon that system and, to the extent possible, subsequent generations of the same vendor’s system, for the life of the application. Once a vendor’s metrology system has been installed, a customer must often make substantial technical modifications and may experience downtime in order to switch to another vendor’s metrology system. Accordingly, unless our systems offer performance or cost advantages that outweigh a customer’s expense of switching to our systems, it will be difficult for us to achieve significant sales from that customer once it has selected another vendor’s system for an application.

If we fail to develop new and enhanced metrology systems we will likely lose market share to our competitors.

We operate in an industry that is subject to technological changes, changes in customer demands and the introduction of new, higher performance systems with short product life cycles. To be competitive, we must continually design, develop and introduce in a timely manner new metrology systems that meet the performance and price demands of semiconductor manufacturers and suppliers. We must also continue to refine our current systems so that they remain competitive. We may experience difficulties or delays in our development efforts with respect to new systems, and we may not ultimately be successful in developing them. Any significant delay in releasing new systems could adversely affect our reputation, give a competitor a first-to-market advantage or cause a competitor to achieve greater market share.

Lack of market acceptance for our new products may affect our ability to generate revenue and may harm our business.

We have recently introduced several products to the market including the Nano CD suite, Nano Station, VerteX Rapid Photoluminescence Mapping System for Compound Semiconductors and Atlas-M. We have invested substantial time and resources into the development of these products. However, we cannot accurately predict the future level of acceptance of our new products by our customers. As a result, we may not be able to generate anticipated revenue from sales of these products. While we anticipate that our new products will become an increasingly larger component of our business, their failure to gain acceptance with our customers could materially harm our business. Additionally, if our new products do gain market acceptance, our ability to sell our existing products may be impeded. As a result, there can be no assurance that the introduction of these products will be commercially successful or that these products will result in significant additional revenues or improved operating margins in future periods.

Our intellectual property may be infringed upon by third parties despite our efforts to protect it, which could threaten our future success and competitive position and harm our operating results.

Our future success and competitive position depend in part upon our ability to obtain and maintain proprietary technology for our principal product families, and we rely, in part, on patent, trade secret and trademark law to protect that technology. If we fail to adequately protect our intellectual property, it will be easier for our competitors to sell competing products. We own or may license patents relating to our metrology systems, and have filed applications for additional patents. Any of our pending patent applications may be rejected, and we may not in the future be able to develop additional proprietary technology that is patentable. In addition, the patents we own, have been issued, or may license may not provide us with competitive advantages and may be challenged by third parties. Third parties may also design around these patents.

In addition to patent protection, we rely upon trade secret protection for our confidential and proprietary information and technology. We routinely enter into confidentiality agreements with our employees. However, in the event that these agreements may be breached, we may not have adequate remedies. Our confidential and proprietary information and technology might also be independently developed by or become otherwise known to third parties. We may be required to initiate litigation in order to enforce any patents issued to or licensed by us, or to determine the scope or validity of a third party’s patent or other proprietary rights. Any such litigation, regardless of outcome, could be expensive and time consuming, and could subject us to significant liabilities or require us to re-engineer our product or obtain expensive licenses from third parties, any of which would adversely affect our business and operating results. In March 2006, we filed a complaint against Nova for infringing our Patent Nos. Re 34,783. In October 2006, we filed a new complaint against Nova for infringement of Patent No. 5,867,276 and 7,115,858. In April 2007, we and Nova agreed to dismiss, without prejudice, all pending patent litigation and have entered into a covenant not to sue one another for any patent for a period of one year.

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If we choose to acquire new and complementary businesses, products or technologies instead of developing them ourselves, we may be unable to complete these acquisitions or may not be able to successfully integrate an acquired business in a cost-effective and non-disruptive manner.

Our success depends on our ability to continually enhance and broaden our product offerings in response to changing technologies, customer demands and competitive pressures. To achieve this, from time to time we have acquired complementary businesses, products, or technologies instead of developing them ourselves and may choose to do so in the future. For example, in May 2008, we consummated our acquisition of Tevet Process Control Technologies, Ltd., an integrated metrology company serving the worldwide semiconductor and solar manufacturing industry. At the outset, we do not know if we will be able to complete any acquisitions, or whether we will be able to successfully integrate any acquired business, operate them profitably or retain their key employees. Integrating any business, product or technology that we acquire could be expensive and time consuming, disrupt our ongoing business and distract our management. In addition, in order to finance any acquisitions, we may be required to raise additional funds through public or private equity or debt financings. In that event, we could be forced to obtain financing on terms that are not favorable to us and, in the case of an equity or convertible debt financing which may result in dilution to our stockholders. If we are unable to integrate any acquired entities, products or technologies effectively, our business will suffer.

We manufacture all of our systems at a limited number of facilities, and any prolonged disruption in the operations of those facilities could reduce our revenues.

We produce all of our systems in our manufacturing facilities located in Milpitas, California and to a lesser extent, we manufacture through our subsidiaries in South Korea and Israel and we also use contract manufacturers in Japan and China. In addition, we perform limited subassembly for certain products at our York England facility. Our manufacturing processes are highly complex and require sophisticated, costly equipment and specially designed facilities. As a result, any prolonged disruption in the operations of our manufacturing facilities, such as those resulting from a severe fire or earthquake, could seriously harm our ability to satisfy our customer order deadlines.

Our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the United States.

In 2007, 2006 and 2005, 68.2%, 65.0% and 66.8%, respectively, of our total net revenues were derived from sales to customers in foreign countries, including certain countries in Asia, such as Japan, South Korea, China and Taiwan. The laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States, and many U.S. companies have encountered substantial problems in protecting their proprietary rights against infringement in such countries. If we fail to adequately protect our intellectual property in these countries, it would be easier for our competitors to sell competing products.

Our results of operations could vary as a result of the methods, estimates and judgments we use in applying our accounting policies.

The methods, estimates and judgments we use in applying our accounting policies have a significant impact on our results of operations, see “Significant Accounting Policies” in Part II, Item 8, Note I of our Form 10-K filed with the SEC on March 13, 2008 and amended on April 25, 2008. Such methods, estimates and judgments are, by their nature, subject to substantial risks, uncertainties and assumptions, and factors may arise over time that leads us to change our methods, estimates and judgments. Changes in those methods, estimates and judgments could significantly affect our results of operations. In particular, the calculation of share-based compensation expense under SFAS No. 123(R) requires us to use valuation methodologies (which were not developed for use in valuing employee stock options) and a number of assumptions, estimates and conclusions regarding matters such as expected forfeitures, expected volatility of our share price, the expected dividend rate with respect to our common stock and the exercise behavior of our employees. Furthermore, there are no means, under applicable accounting principles, to compare and adjust our expense if and when we learn of additional information that may affect the estimates that we previously made, with the exception of changes in expected forfeitures of share-based awards. Factors may arise over time that leads us to change our estimates and assumptions with respect to future share-based compensation arrangements, resulting in variability in our share-based compensation expense over time. Changes in forecasted share-based compensation expense could impact our gross margin percentage; research and development expenses; marketing, general and administrative expenses; and our tax rate.

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Our quarterly operating results have varied in the past and probably will continue to vary significantly in the future, which will cause volatility in our stock price.

Our quarterly operating results have varied significantly in the past and are likely to vary in the future, which volatility could cause our stock price to decline. Some of the factors that may influence our operating results and subject our stock to extreme price and volume fluctuations include:

• changes in customer demand for our systems;

• economic conditions in the semiconductor industries;

• the timing, cancellation or delay of customer orders and shipments;

• market acceptance of our products and our customers’ products;

• our ability to recover the higher costs associated with meeting our customers’ increasing service demands;

• competitive pressures on product prices and changes in pricing by our customers or suppliers;

• the timing of new product announcements and product releases by us or our competitors and our ability to design, introduce and manufacture new products on a timely and cost-effective basis;

• the timing of acquisitions of businesses, products or technologies;

• the levels of our fixed expenses, including research and development costs associated with product development, relative to our revenue levels; and

• fluctuations in foreign currency exchange rates, particularly the Japanese yen and the Great British Pound.

If our operating results in any period fall below the expectations of securities analysts and investors, the market price of our common stock would likely decline.

We incur increased costs as a result of changes in laws and regulations affecting public companies.

Compliance with changes in laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, has resulted in and, we expect, will continue to result in substantial accounting, legal and administrative costs. In particular, Section 404 of the Sarbanes-Oxley Act of 2002 and the rules of the SEC and the Public Company Accounting Oversight Board impose requirements with respect to the evaluation of the effectiveness of our internal controls. The cost of complying with these requirements is substantial.

We are highly dependent on international sales and operations, which exposes us to foreign political and economic risks.

We maintain facilities in Japan, Taiwan, United Kingdom, South Korea, China and the European Union. We anticipate that international sales will continue to account for a significant portion of our revenues. International sales and operations carry inherent risks such as: regulatory limitations imposed by foreign governments, obstacles to the protection of our intellectual property, political, military and terrorism risks, disruptions or delays in shipments caused by customs brokers or other government agencies, unexpected changes in regulatory requirements, tariffs, customs, duties and other trade barriers, difficulties in staffing and managing foreign operations, and potentially adverse tax consequences resulting from changes in tax laws. If any of these risks materialize and we are unable to manage them, our international sales and operations would suffer.

We are exposed to fluctuations in the exchange rates of foreign currency.

As a global concern, we face exposure to adverse movements in foreign currency exchange rates. With our operations in Japan, South Korea, United Kingdom, Taiwan, the European Union, China and Israel, a significant percentage of our cash flows are exposed to foreign currency risk. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results and cash flow.

We are subject to various environmental laws and regulations that could impose substantial costs upon us and may harm our business, operating results and financial condition.

Some of our operations use substances regulated under various federal, state, local, and international laws governing the environment, including those relating to the storage, use, discharge, disposal, labeling, and human exposure to hazardous and toxic materials. We could incur costs, fines and civil or criminal sanctions, third-party property damage or personal injury claims, or could be required to incur substantial investigation or remediation costs, if we were to violate or become

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liable under environmental laws. Liability under environmental laws can be joint and several and without regard to comparative fault. Compliance with current or future environmental laws and regulations could restrict our ability to expand our facilities or require us to acquire additional expensive equipment, modify our manufacturing processes, or incur other significant expenses. There can be no assurance that violations of environmental laws or regulations will not occur in the future as a result of the inability to obtain permits, human error, equipment failure or other causes.

Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company and may affect the trading price of our common stock.

In September 2006, we changed our state of incorporation from California to Delaware. The anti-takeover provisions of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our certificate of incorporation and bylaws may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable. Our certificate of incorporation and bylaws:

• authorize the issuance of “blank check” preferred stock that could be issued by our board of directors to thwart a takeover attempt;

• establish a classified board of directors, as a result of which the successors to the directors whose terms have expired will be elected to serve from the time of election and qualification until the third annual meeting following their election;

• limit who may call special meetings of stockholders; and

• prohibit stockholder action by written consent, requiring all actions to be taken at a meeting of the stockholders.

Continuing economic and political instability could affect our business and results of operations.

The semiconductor industry is cyclical in nature and has historically experienced periodic downturns and upturns. Today’s leading indicators of changes in customer investment patterns may not be any more reliable than in prior years. Demand for our equipment can vary significantly from period to period as a result of various factors, requirements, and our ability to develop, acquire, and market competitive products. For these and other reasons, our current results of operations may not necessarily be indicative of future operating results.

The ongoing threat of terrorism targeted at the United States or other regions where we conduct business increases the uncertainty in our markets and the economy in general. This uncertainty is likely to result in economic stagnation, which would harm our business. In addition, increased international political instability may hinder our ability to do business by increasing our costs of operations. For example, our transportation costs, insurance costs and sales efforts may become more expensive as a result of geopolitical tension. These tensions may also negatively affect our suppliers and customers. If this international economic and political instability continues or increases, our business and results of operations could be harmed.

We may not maintain Nasdaq listing requirements, which would adversely affect the price and liquidity of our common stock.

To maintain the listing of our common stock on The Nasdaq Global Market, we are required to meet certain listing requirements, including a minimum bid price of $1.00 per share. If our stock trades below the $1.00 minimum bid price for 30 consecutive business days, Nasdaq may choose to notify us that it may delist our common stock from The Nasdaq Global Market. If the closing bid price of our common stock did not thereafter regain compliance for a minimum of 10 consecutive trading days during the 180 days following notification by Nasdaq, Nasdaq could delist our common stock from trading on The Nasdaq Global Market. There can be no assurance that our common stock will remain eligible for trading on The Nasdaq Global Market. If our stock were delisted, the ability of our stockholders to sell any of our common stock at all would be severely, if not completely, limited, causing our stock price to continue to decline.

35

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

We repurchased the following shares of our common stock during the nine-month period ended September 27, 2008:

Issuer Purchase of Equity Securities

Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of a Publicly Announced Programs	Maximum Dollar Value of Shares that May Yet Be Purchased Under the Program
Month Ending July 26, 2008	—		—	—	$	2,725,261
Month Ending August 23, 2008	71,782	$	4.04	71,782	$	2,435,356
Month Ending September 27, 2008	313,725	$	3.22	313,725	$	1,424,629
Total	385,507	$	3.37	385,507

(1) On July 26, 2007, our Board of Directors approved the repurchase of up to $4.0 million of our common stock. Share repurchases under this program may be made through open market and privately negotiated transactions, at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements and other market conditions. The stock repurchase program may be limited or terminated at any time without prior notice. As of September 27, 2008, there remained $1.4 million available for the future purchase of shares of our common stock.

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

None

ITEM 6. EXHIBITS

Exhibit Index

The following exhibits are filed or incorporated by reference with this Quarterly Report on Form 10-Q:

Exhibit No.	Description
3.(i)	Certificate of Incorporation
3.1(1)	Certificate of Incorporation of the Registrant
3.(ii)	Bylaws
3.2(2)	Bylaws of the Registrant
10	Material Contracts Management Contracts, Compensatory Plans, Contracts or Arrangements
10.1(3)	Asset purchase agreement by and between Tevet Process Control Technologies, Ltd., and Nanometrics-Israel Ltd., dated May 7, 2008
10.2	Security Agreement, Balloon Promissory Note, and Deed of Trust by and between GE Commercial Finance Business Property Corporation and Nanometrics Incorporated each dated July 25, 2008
10.3	Confidential Settlement Agreement and General Release by and between Gary C. Schaefer and Nanometrics Incorporated dated September 5, 2008
31	Rule 13a-14(a)/15d-14(a) Certifications
31.1	Certification of Timothy J. Stultz, principal executive officer of the Registrant, pursuant to rule 13a-14(a) or rule 15a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Bruce A. Crawford, principal financial officer of the Registrant, pursuant to rule 13a-14(a) or rule 15a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

36

32	Section 1350 Certifications
32.1	Certification of Timothy J. Stultz, principal executive officer of the Registrant, and Bruce A. Crawford, principal financial officer of the Registrant, pursuant to rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1) Incorporated by reference to exhibits filed with the Registrant’s Current Report on Form 8-K filed October 5, 2007.

(2) Incorporated by reference to Exhibit 3.2 filed with the Registrant’s Current Report on Form 10-8 filed May 7, 2008.

(3) Incorporated by reference to exhibits filed with the Registrant’s Current Report on Form 8-K filed May 5, 2008 and Form 8-K/A filed May 7, 2008.

37

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

NANOMETRICS INCORPORATED (Registrant)
By:	/s/ Bruce A. Crawford
	Bruce A. Crawford
	Chief Financial Officer

Dated: November 6, 2008

38

EX-10.2

Exhibit 10.2

Loan No.: 6326048-001

SECURITY AGREEMENT

(1550 Buckeye Drive, Milpitas, Santa Clara County, California)

Debtor:
Name:	NANOMETRICS INCORPORATED, a Delaware corporation
Address:	1550 Buckeye Drive, Milpitas, California 95035-7418
Secured Party:
Name:	GE COMMERCIAL FINANCE BUSINESS PROPERTY CORPORATION,
	A Delaware corporation, its successors and assigns
Address:	Middle Market Risk
	10900 Northeast Fourth Street, Suite 500
	Bellevue, Washington 98004

THIS SECURITY AGREEMENT is made, given, and entered into as of July 25, 2008, by the Debtor named above to and for the benefit of the Secured Party. Debtor, for valuable consideration, hereby grants to Secured Party a security interest in the property listed on Exhibit B hereto, and any and all additions and substitutions thereto (the “Collateral”) (i) to secure payment of the indebtedness evidenced by that certain Balloon Promissory Note of even date herewith, payable to the order of Secured party, in the principal amount of Thirteen Million Five Hundred Thousand and no hundredths Dollars ($13,500,000.00.00) (the “Note”) and (ii) to secure all other obligations of Debtor arising under all documents (collectively, the “Loan Documents”) securing or executed in connection with the Note, except the Environmentally Indemnity Agreement Regarding Hazardous Substances (“Indemnity”).

Debtor expressly warrants and covenants:

1. Except for the security interest granted hereby, Debtor is, or to the extent that this Security Agreement states that the Collateral is to be acquired after the date hereof, will be, the owner of the Collateral free from any lien, security interest or encumbrance, other than the Permitted Exceptions (as defined in the Security Instrument as hereinafter defined). Debtor understands that any further encumbrance of the Collateral is prohibited. Debtor shall defend the Collateral against all claims and demands of all persons at any time claiming the same of any interest therein by, through or under Debtor.

2. The Collateral is used or brought primarily for use in the business of Debtor and not for consumer purposes.

3. The Collateral is located at or on or is used or owned for or in connection with the real estate situated in Milpitas, Santa Clara County, California, commonly known as 1550 Buckeye Drive, and described on the attached Exhibit A herein incorporated by this reference (the “Property”). Debtor shall promptly notify Secured Party of any change in the location of the Collateral.

4. Debtor is a corporation formed under the laws of the State of Delaware. Debtor’s business address is as stated above. Debtor shall promptly notify Secured Party of any change in Debtor’s principal place of business or organizational status.

5. Debtor shall pay when due, prior to delinquency, all taxes and assessments of every nature which may be levied or assessed against the Collateral.

6. Except for liens in favor of Secured Party, without Secured Party’s prior written consent, Debtor shall not permit or allow any lien, security interest or encumbrance whatsoever upon the Collateral (other than the Permitted Exceptions described in the Security Instrument and any other liens permitted under the Loan Documents) and shall not permit the Collateral to be attached or replevied. Secured Party’s consent to a junior lien by an entity owned by, or under common control with, Secured Party shall not be unreasonably withheld.

7. The Collateral is in good condition and Debtor shall keep the Collateral in good condition (reasonable wear and tear expected) and from time to time, forthwith, replace and repair all such parts of the Collateral as may be broken, worn out, or damaged without allowing any lien to be created upon the Collateral on account of such replacement or repairs. Secured Party may examine and inspect the Collateral at any time, wherever located, subject to reasonable prior notice.

8. Debtor will not use the Collateral in violation of any applicable statutes, regulations or ordinances.

Notwithstanding anything else contained herein or in any of the Loan Documents to the contrary, if any personal property for use on the Property will be leased to Debtor, Secured Party’s interest therein shall be subordinate to lessor’s interest therein.

Until the occurrence of an “Event of Default” (as hereinafter defined), Debtor may have possession of the Collateral and use it in any lawful manner, and upon the occurrence of an Event of Default Secured Party shall have the immediate right to the possession of the Collateral to the extent and in the manner provided by applicable law.

Debtor shall be in default under this Security Agreement upon the happening of any of the following events (an “Event of Default”):

(a) default in the payment or performance of any obligation, covenant or liability contained or referred to in this Security Agreement (provided, however, that Debtor shall have been given as to Nos. 5, 6, 7 and 8 above, thirty (30) days written notice and opportunity to cure, or if the default cannot be cured within such thirty (30)-day period, such additional time as may be reasonably required to commence and pursue curative action with reasonable diligence); provided, however, that no notice of default and no opportunity to cure shall be required with respect to defaults under Nos. 6 and 7 if during the prior twelve (12) months Secured Party has already sent more than one (1) notice to Debtor concerning default in performance of the same obligation); or

(b) the occurrence of an “Event of Default” as defined under the Note (which defined term includes applicable notice and grace periods), any instrument securing the Note, including the Commercial Deed of Trust, Security Agreement, Assignment of Leases and Rents, Financing Statement and Fixture Filing securing the Note (the “Security Instrument”), or any other Loan Document; or

(c) the loss, theft, damage or destruction to or of any of the Collateral as to which adequate insurance has not been provided which shall materially and substantially diminish the aggregate value of the Collateral, if the lost, stolen, damaged or destroyed items are not repaired or replaced within thirty (30) days after the date of the loss, theft, damage or destruction and, in the case of any replacement, with new items which are comparable in value to the items lost, stolen, damaged or destroyed and with respect to which Secured Party is granted a security interest; or

(d) the sale of the encumbrance of any of the Collateral except in the ordinary course of business or except Collateral which is immediately replaced with similar collateral of equal or greater value; or

(e) the making of any levy, seizure or attachment on or to the Collateral which is not released or dismissed within ninety (90) days.

Upon the occurrence of an Event of Default, Secured Party may declare the Note immediately due and payable and shall have the remedies of a secured party under the Articles of the Uniform Commercial Code as adopted in the State of California (the “UCC”). Secured Party may require Debtor to assemble the Collateral and deliver or make it available to Secured Party at a place to be designated by Secured Party which is reasonably convenient to both parties.

Secured Party may require that the Collateral be sold at a public sale at the same time and place as the sale of the Property, or Secured Party may sell the Collateral at one or more other public or private sales in accordance with the UCC. The Collateral shall not be required to be exhibited, presented or displayed at any sale. In the event that the Collateral is sold under the Security Instrument, Secured Party hereby assigns its security interest in the Collateral to the trustee or sheriff selling the Property under the Security Instrument. Debtor agrees that a sale of the Collateral under the Security Instrument and the notices required under the laws of the State of California for the sale of real property are commercially reasonable and adequate under the UCC.

Debtor agrees to pay to Secured Party in addition to the indebtedness secured hereby, all expenses of retaking, holding, preparing for sale and selling incurred by Secured Party in connection with realization on the Collateral including reasonable attorneys’ fees and costs. In addition, in the event suit or action is instituted to enforce or interpret this Security Agreement (including without limitation efforts to modify or vacate any automatic stay or injunction), the prevailing party shall be entitled to recover all expenses reasonably incurred at, before or after trial and on appeal whether or not taxable as costs, or in any bankruptcy proceeding, including, without limitation, reasonable attorneys’ fees, witness fees (expert and otherwise), deposition costs, copying charges and other expenses.

Secured Party may at any time and from time to time, file financing statements, continuation statements and amendments thereto that describe the Collateral as set forth in Exhibit B or words of similar effect and which contain any other information required for the sufficiency of any financing statement, continuation statement or amendment, including whether the Debtor is an organization, the type of organization and any organization identification number issued to the Debtor. Debtor agrees to furnish any such information to Secured Party promptly upon request. Any such financing statements, continuation statements or amendments may be signed by Secured Party on behalf of Debtor, and may be filed at any time in any jurisdiction.

In addition, Debtor shall at any time and from time to time take such steps as Secured Party may reasonably request for Secured party (a) to obtain an acknowledgement, in form and substance satisfactory to Secured Party, of any bailee having possession of any of the Collateral that the bailee holds such Collateral for Secured Party, (b) to obtain “control” of any investment property, deposit accounts, letter of credit rights or electronic chattel paper (as such terms are defined in the UCC), with any agreements establishing control to be in form and substance satisfactory to Secured Party, and (c) to otherwise insure the continued perfection and priority of Secured Party’s security interest in any of the Collateral and the preservation of its right therein.

Nothing contained herein shall be construed to narrow the scope of Secured Party’s security interest in any of the Collateral or the perfection of priority thereof or to impair or otherwise limit any of the rights, powers, privileges or remedies of Secured Party hereunder except (and then only to the extent) mandated by the UCC.

No waiver by Secured Party of an Event of Default shall operate as a waiver of any other default or of the same default on a future occasion. The taking of this Security Agreement shall not waive or impair any other security said Secured Party may have or hereafter acquire for the payment of the Note nor shall the taking of any such additional security waive or impair this Security Agreement. Secured Party may resort to any security it may have in the order it may deem proper.

All rights of Secured Party hereunder shall inure to the benefit of its successors and assigns. All promises and duties of Debtor shall bind its successors and assigns.

Any and all notices, elections, demands, or requests permitted or required to be made under this Security Agreement shall be in writing, signed by the party giving such notice, election, demand or request, and shall be delivered personally, or sent by registered, certified, or Express United States mail, postage prepaid, or by Federal Express or similar service requiring a receipt, to the other party at the address set forth above or to such other party and at such other address within the United States of America as any party may designate as provided herein. The date of receipt of such notice, election, demand or request shall be the earliest of (i) the date of actual receipt, (ii) three (3) business days after the date of mailing by registered or certified mail, (iii) one (1) business day after the date of mailing by Express Mail, or the delivery (for redelivery) to Federal Express or another similar service requiring a receipt, or (iv) the date of personal delivery (or refusal upon presentation for delivery).

This Security Agreement shall be governed and construed in accordance with the laws of the State of California applicable to contracts made and to be performed therein (without regard to choice of law principles).

To the extent of any conflict between the provisions of this Security Agreement and the provisions of Section 14 of the Security Instrument, the provisions of this Security Agreement shall control.

WAIVER OF JURY TRIAL. DEBTOR AND SECURED PARTY HEREBY KNOWINGLY, VOLUNTARILY AND INTELLIGENTLY WAIVE ANY AND ALL RIGHTS THAT EACH PARTY TO THIS SECURITY AGREEMENT MAY NOW OR HEREAFTER HAVE UNDER THE LAWS OF THE UNITED STATES OF AMERICA OR THE STATE OF CALIFORNIA, TO A TRIAL BY JURY OF ANY AND ALL ISSUES ARISING DIRECTLY OR INDIRECTLY IN ANY ACTION OR PROCEEDING RELATING TO THIS SECURITY AGREEMENT, THE LOAN DOCUMENTS OR ANY TRANSACTIONS CONTEMPLATED THEREBY OR RELATED THERETO. IT IS INTENDED THAT THIS WAIVER SHALL APPLY TO ANY AND ALL DEFENSES, RIGHTS, CLAIMS AND/OR COUNTERCLAIMS IN ANY SUCH ACTION OR PROCEEDING. DEBTOR UNDERSTANDS THAT THIS WAIVER IS A WAIVER OF A CONSTITUTIONAL SAFEGUARD, AND EACH PARTY INDIVIDUALLY BELIEVES THAT THERE ARE SUFFICIENT ALTERNATE PROCEDURAL AND SUBSTANTIVE SAFEGUARDS, INCLUDING, A TRIAL BY AN IMPARTIAL JUDGE, THAT ADEQUATELY OFFSET THE WAIVER CONTAINED HEREIN.

TIME IS OF THE ESSENCE UNDER THIS SECURITY AGREEMENT.

IN WITNESS WHEREOF, Debtor has executed or caused this Security Agreement to be executed as of the year and day first written above.

DEBTOR:
NANOMETRICS INCORPORATED, A Delaware corporation
By:	/s/ Gary Schaefer

Printed Name: Gary Schaefer

Title: Chief Financial Officer

EXHIBITS:

Exhibit A – Legal Description

Exhibit B – Personal Property

Loan No.: 6326048-001

EXHIBIT A

(1550 Buckeye Drive, Milpitas, Santa Clara County, California)

Legal Description:

Real property in the City of Milpitas, County of Santa Clara, State of California, described as follows:

PARCEL ONE:

PARCEL 1, AS SHOWN ON PARCEL MAP FILED NOVEMBER 4, 1998 IN BOOK 709 OF MAPS, AT PAGE(S) 41 AND 42, SANTA CLARA COUNTY RECORDS.

PARCEL TWO:

PERMANENT NON-BUILDING EASEMENT OVER A PORTION OF PARCEL 3, AS SHOWN ON PARCEL MAP ABOVE REFERRED TO.

PARCEL THREE:

TWO 10’ WIDE PRIVATE STORM DRAINAGE EASEMENTS OVER PARCEL 3, AS SHOWN ON PARCEL MAP ABOVE REFERRED TO.

PARCEL FOUR:

RECIPROCAL EMERGENCY ACCESS EASEMENT OVER PARCEL 3, AS SHOWN ON PARCEL MAP ABOVE REFERRED TO.

APN: 086-03-093

EXHIBIT B

(1550 Buckeye Drive, Milpitas, Santa Clara County, California)

Secured Party:	GE COMMERCIAL FINANCE BUSINESS PROPERTY CORPORATION,
	A Delaware corporation, its successors and assigns
Debtor:	NANOMETRICS INCORPORATED, a Delaware corporation
Loan No.:	6326048-001

The collateral includes all of the right, title and interest of Debtor in, to and under:

1. All fixtures, landscaping, equipment, and articles of property now or hereafter attached to, or used or adapted for use in the operation of buildings, structures, improvements, and parking areas located on the real estate (herein the “Premises”) described in Exhibit A, including but without being limited to, all heating, air conditioning, lighting, and incinerating apparatus and equipment; all boilers, engines, motors, dynamos, generating equipment, piping and plumbing fixtures, water heaters, cooling, ventilating, sprinkling and vacuum cleaning systems, fire extinguishing apparatus, gas and electric fixtures, carpeting, floor covering, underpadding, elevators, escalators, partitions, mantels, built-in mirrors, window shades, blinds, draperies, screens, storm sash, awnings, and shrubbery and plats, and including also all interest of any owner of the Premises in any of such items hereafter at any time acquired under conditional sale contract, chattel mortgage or other title retaining or security instrument, all of which property mentioned in this paragraph 1 shall be referred to as the “Improvements” and shall be deemed part of the realty and not severable wholly or in part without material injury to the freehold of the Premises.

2. All compensation, awards, damages, rights of action and proceeds, including interest thereon and/or the proceeds of any policies of insurance therefor, arising out of or relating to a (a) taking or damaging of the Premises or Improvements thereon by reason of any public or private improvement, condemnation proceeding (including change of grade), sale or transfer in lieu of condemnation, or fire, earthquake or other casualty, or (b) any injury to or decrease in the value of the Premises or the Improvements for any reason whatsoever.

3. Return premiums or other payments upon any insurance any time provided for the benefit of or naming Secured Party with respect to the Premises, Improvements and other collateral described herein, and refunds or rebates of taxes or assessments on the Premises.

4. All written and oral leases and rental agreements (including extensions, renewals and subleases; all of the foregoing shall be referred to collectively herein as the “Leases”) now or hereafter affecting the Premises including, without limitation, all rents, issues, profits and other revenues and income therefrom and from the renting, leasing or bailment of Improvements, all guaranties of tenants’ performance under the Leases, and all rights and claims of any kind that Debtor may have against any tenant under the Leases or in connection with the termination or rejection of the Leases in a bankruptcy or insolvency proceeding.

5. Plans, specifications, contracts and agreements relating to the design or construction of the Improvements; Debtor’s rights under any payment, performance, or other bond in connection with the design or construction of the Improvements; all landscaping and construction materials, supplies, and equipment used or to be used or consumed in connection with construction of the Improvements, whether stored on the Premises or at some other location; and contracts, agreements, and purchase orders with contractors, subcontractors, suppliers, and materialmen incidental to the design or construction of the Improvements.

Secured Party:	GE COMMERCIAL FINANCE BUSINESS PROPERTY CORPORATION,
	A Delaware corporation, its successors and assigns
Debtor:	NANOMETRICS INCORPORATED, a Delaware corporation
Loan No.:	6326048-001

6. all contracts, deposits, rights, claims or causes of action pertaining to the operation, sale or leasing of the Premises or the Improvements, including, without limitation, all options or contracts to acquire other property for use in connection with operation or development of the Premises or Improvements, management contracts, service or supply contracts, permits, licenses, franchises and certificates, and all commitments or agreements, now or hereafter in existence, intended by the obligor thereof to provide Debtor with proceeds to satisfy the loan evidenced hereby or improve the Premises or Improvements, and the right to receive all proceeds due under such commitments or agreements including refundable deposits and fees.

7. All books, records, surveys, reports and other documents related to the Premises, the Improvements, the Leases, or other items of collateral described herein.

8. All additions, accessions, replacements, substitutions, proceeds and products of the real and personal property, tangible and intangible, described herein, including but not limited to lease and real-estate proceeds and other amounts relating to the use, disposition, or sale of the collateral described herein which proceeds or other amounts are characterized as general intangibles.

All of the foregoing described collateral is exclusive of any goods, inventory, equipment, furniture, furnishings, trade fixtures, and other personal property owned or supplied by Debtor or tenants of the Premises.

FURTHER ENCUMBRANCE OF THE ABOVE COLLATERAL IS PROHIBITED.

Loan No.: 6326048-001

BALLOON PROMISSORY NOTE

(Rate Reset)

(1550 Buckeye Drive, Milpitas, Santa Clara County, California)

$13,500,000.00 July 25, 2008

FOR VALUE RECEIVED, NANOMETRICS INCORPORATED, a Delaware corporation (“Borrower”), promises to pay to the order of GE COMMERCIAL FINANCE BUSINESS PROPERTY COPORATION, a Delaware corporation (“Payee”; Payee and any subsequent holder of this Balloon Promissory Note (this “Note”) being referred to herein as “Holder”), at Payee’s office at 10900 Northeast Fourth Street, Suite 500, Bellevue, Washington 98004, attention: Middle Market Risk, or at such other address as Holder may form time to time designate in writing, the principal sum of Thirteen Million Five Hundred Thousand and no hundredths Dollars ($13, 500,000.00) together with interest from the date the proceeds of the loan (the “Loan”) evidenced by this Note are initially disbursed (including, without limitation, disbursement into an escrow for the benefit of Borrower) until Maturity (as defined below) on the principal balance from time to time remaining unpaid hereon at the rates set forth below.

A single payment of interest only in advance at the rate of $2,692.50 per day, representing interest through July 31, 2008, at the Initial Rate (as defined below) shall be due and payable on the date that funds are advanced hereunder. Sixty (60) consecutive monthly installments of principal and interest at the Initial Rate in the about of $106,946.68 each (which represents an amount which would amortize the principal face amount of this Note in full at the Initial Rate over a period of two hundred forty (240) months), shall be due and payable, commencing on September 1, 2008, and continuing on the first day of each and every succeeding month thereafter through August 1, 2013 (the “Re-Amortization Date”). As of the Re-Amortization Date, the principal balance remaining hereunder shall be re-amortized at the Reset Rate (as defined below), over a period of one hundred eighty (180) months. Fifty-nine (59) payments of principal and interest as computed above at the Reset Rate shall be due and payable, commencing on September 1, 2013 and continuing on the first day of each and every succeeding month thereafter through July 1, 2018, and on August 1, 2018 (“Maturity”), all unpaid principal and interest hereon shall be due and payable.

The Initial Rate shall be Seven and eighteen hundredths percent (7.18%) per annum. The Reset Rate shall be equal to the weekly average yield of five (5)-year U.S. Dollar Interest Rate Swaps in effect as of the Re-Amortization Date (as published in Federal Reserve Statistical Release H.15[519]) (the “Index”), plus three hundred three (303) basis points. If the Index is no longer published in Federal Reserve Statistical Release H.15[519] or if the method for compiling the Index is (as determined in Holder’s reasonable discretion) materially altered, then Holder shall select such replacement index as Holder in its sole discretion determines most closely approximates the Index. Interest shall be computed on the basis of a 360-day year and actual days elapsed up to a maximum of 365 days.

All payments of the principal and interest on this Note shall be made in coin or currency of the United States of America which at the time shall be the legal tender for the payment of public and private debts.

Borrower shall authorize and make such arrangements as may be necessary to enable Holder to obtain payments due under this Note and the other Loan Documents through the automated clearing house system (“ACH System”). Such authorizations and arrangements shall include, without limitation, establishing and maintaining an account with a commercial bank that is a member of the ACH System and entering into an ACH System agreement with Holder.

If any payment (other than the final, balloon payment, if any) shall not be received by Holder within ten (10) days after its due date, Borrower shall pay an additional charge equal to five percent (5.00%) of the delinquent payment or the highest additional charge permitted by law, whichever is less. A late charge of $1,000.00 will be assessed with respect to any delinquent balloon payment.

Except as is expressly provided for herein, this Note may not be prepaid in whole or in part without the prior written consent of Holder. Upon payment of a “Prepayment Fee” calculated as set forth below (the “Prepayment Fee”), Borrower shall have the right to prepay all, but not less than all, of the outstanding balance of this Note. The Prepayment Fee shall be determined by calculating the “Base Fee” by multiplying the “Base Fee Factor” set forth below by the principal balance to be prepaid and, if the Fixed Rate shall have been elected, adding it to the “Variable Fee”, which is determined by (i) calculating the decrease (expressed in basis points) in the current weekly average yield of Five (5)-year U.S. Dollar Interest Rate Swaps (as published in Federal Reserve Statistical Release H.15[519]) (the “Index”) from Friday, April 4, 2008, or the Re-Amortization Date, as applicable, to the prepayment date, (ii) dividing the decrease by 100, (iii) multiplying the result by the following described “Variable Fee Factor”, and (iv) multiplying the product by the principal balance to be prepaid. If the Index is unchanged or has increased from Friday, April 4, 2008, or the Re-Amortization Date, as applicable, to the prepayment date, no Variable Fee shall be due. The Base Fee Factor and the Variable Fee Factor shall be as shown on the following chart for the month in which prepayment occurs:

No. Mos. Remaining	(Years)		Base Fee Factor	Variable Fee Factor
120 – 109	(10	)	.050	.044
108 – 97	(9	)	.040	.037
96 – 85	(8	)	.030	.030
84 – 73	(7	)	.020	.022
72 – 61	(6	)	.010	.014
60 – 49	(5	)	.0	.044
48 – 37	(4	)	.0	.037
36 – 25	(3	)	.0	.030
24 – 13	(2	)	.0	.022
12 – 1	(1	)	.0	.014

If the Federal Reserve Board ceases to publish Statistical Release H.15 [519], or if the method for compiling the Index is (as determined in Holder’s sole discretion) materially altered, then Holder shall select such replacement index as Holder in its reasonable discretion determines most closely approximates the Index.

Notwithstanding any prepayment requirement or restriction to the contrary in this Note, and provided no Event of Default has occurred and remains uncured, Borrower may partially prepay this Note from time to time on the due date for any scheduled installment of principal and interest, so long as any such partial prepayment (i) does not occur within twelve (12) months of any other such partial prepayment and (ii) does not exceed twenty percent (20%) of the principal balance of this Note outstanding at the time of such prepayment. Any such partial prepayment shall be without obligation for any Prepayment Fee.

If Holder at any time accelerates this Note after an Event of Default (defined below), then Borrower shall be obligated to pay the Prepayment Fee calculated as set forth above. The Prepayment Fee shall not be payable in the case of an assumption of the Loan (if permitted by Holder pursuant to the terms

of the Security Instrument (as hereinafter defined)), nor with respect to condemnation awards or insurance proceeds from fire or other casualty which Holder applies to prepayment, nor with respect to Borrower’s prepayment of the Note in full during the last 90 days preceding the Re-Amortization Date or during the last 90 days of the term of this Note unless an Event of Default has occurred and remains uncured. Borrower expressly acknowledges that such Prepayment Fee is not a penalty but is intended solely to compensate Holder for the loss of its bargain and the reimbursement of internal expenses and administrative fees and expenses incurred by Holder.

BORROWER HEREBY EXPRESSLY (1) WAIVES ANY RIGHTS IT MAY HAVE UNDER CALIFORNIA CIVIL CODE SECTION 2954.10 TO PREPAY THIS NOTE, IN WHOLE OR IN PART, WITHOUT PENALTY, UPON ACCELERATION OF THE MATURITY DATE OF THIS NOTE, AND (2) AGREES THAT IF, FOR ANY REASON, A PREPAYMENT OF ANY OR ALL OF THIS NOTE IS MADE, WHETHER VOLUNTARY OR UPON OR FOLLOWING ANY ACCELERATION OF THE MATURITY DATE OF THIS NOTE BY HOLDER ON ACCOUNT OF ANY EVENT OF DEFAULT BY BORROWER UNDER THIS NOTE, THE SECURITY INSTRUMENT OR ANY OTHER DOCUMENT EVIDENCING OR SECURING THE LOAN, INCLUDING, BUT NOT LIMITED TO, ANY TRANSFER OR DISPOSITION AS PROHIBITED OR RESTRICTED BY THE PROVISIONS OF THE SECURITY INSTRUMENT, THEN BORROWER SHALL BE OBLIGATED TO PAY, CONCURRENTLY THEREWITH, THE PREPAYMENT FEE. BY SIGNING THIS PROVISION IN THE SPACE PROVIDED BELOW, BORROWER AGREES THAT HOLDER’S AGREEMENT TO MAKE THE LOAN EVIDENCED BY THIS NOTE AT THE INTEREST RATE AND FOR THE TERM SET FORTH IN THIS NOTE CONSTITUTES ADEQUATE CONSIDERATION, GIVEN INDIVIDUAL WEIGHT BY BORROWER FOR THIS WAIVER AND AGREEMENT.

BORROWER ______________

The Loan is secured, in part, by a certain Commercial Deed of Trust, Security Agreement, Assignment of Leases and Rents, Financing Statement and Fixture Filing (the “Security Instrument”) covering the real property and other assets (the “Property”) described therein, and by certain other documents executed and delivered in connection herewith (this Note, the Security Instrument and such other documents are collectively called the “Loan Documents”).

To the extent permitted by applicable law, Holder shall have full recourse against Borrower for all sums due under this Note and for all the representations, warranties, indemnities and covenants in the Security Instrument and all other Loan Documents.

Each of the following shall constitute an Event of Default (“Event of Default”) hereunder and under the Security Instrument:

(a) Failure of Holder to receive any payment of principal, interest, or Prepayment Fee upon this Note when due, and such failure shall continue for ten (10) days after written notice is given to Borrower of the same; or

(b) The occurrence of an “Event of Default” as defined in any Loan Document (other than this Note).

Upon this occurrence of any Event of Default, Holder shall have the option to declare the entire amount of principal and interest due under this Note immediately due and payable without notice or demand, and Holder may exercise any of its rights under this Note and any document executed or delivered herewith. After acceleration or Maturity, Borrower shall pay interest on the outstanding principal balance of this Note at the rate of fifteen percent (15.00%) per annum or the maximum interest rate permitted by law, whichever is less (the “Default Rate”).

If this Note is placed in the hands of an attorney for collection, Borrower shall pay reasonable attorneys’ fees and costs incurred by Holder in connection therewith, and in the event suit or action is instituted to enforce or interpret this Note (including without limitation efforts to modify or vacate any automatic stay or injunction), the prevailing party shall be entitled to recover all expenses reasonably incurred at, before or after trial and on appeal, whether or not taxable as costs, or in any bankruptcy proceeding, or in connection with post-judgment collection efforts, including, without limitation, reasonable attorneys’ fees, witness fees (expert and otherwise), deposition costs, copying charges and other expenses.

This Note shall be governed and construed in accordance with the laws of the State of California applicable to contracts made and to be performed therein (excluding choice-of-law principles). Borrower hereby irrevocably submits to the jurisdiction of any state or federal court sitting in California in any action or proceeding brought to enforce or otherwise arising out of or relating to this Note, and hereby waives any objection to venue in any such court and any claim that such forum is an inconvenient forum.

This Note is given in a commercial transaction for business purposes.

This Note may be declared due prior to its expressed Maturity, all in the events, on the terms, and in the manner provided for in the Security Instrument.

Borrower and all sureties, endorsers, guarantors and other parties now or hereafter liable for the payment of this Note, in whole or in part, hereby severally (i) waive demand, notice of demand, presentment for payment, notice of nonpayment, notice of default, protest, notice of protest, notice of intent to accelerate, notice of acceleration and all other notices except those for which the Loan Documents expressly provide, and further waive diligence in collecting this Note or in enforcing any of the security for this Note; (ii) agree to any substitution, subordination, exchange or release of any security for this note or the release of any party primarily or secondarily liable for the payment of this note; (iii) agree that, to the extent permitted under applicable law, Holder shall not be required to first institute suit or exhaust it remedies hereon against Borrower or other liable or to become liable for the payment of this Note or to enforce its rights against any security for the payment of this Note; and (iv) consent to any extension of time for the payment of this Note, or any installment hereof, made by agreement by Holder with any person now or hereafter liable for the payment of this Note, even if Borrower is not a party to such agreement.

Borrower authorizes Holder or its agent to insert in the spaces provided herein the appropriate interest rate and the payment amounts as of the date of the initial advance hereunder.

All agreements between Borrower and Holder, whether now existing or hereafter arising and whether written or oral, are hereby limited so that in no contingency, whether by reason of demand or acceleration of the final maturity of this Note or otherwise, shall the interest contracted for, charged, received, paid or agreed to be paid to Holder exceed the maximum amount permissible under the applicable law. If, from any circumstance whatsoever, interest would otherwise be payable to Holder in excess of the maximum amount permissible under applicable law, the interest payable to Holder shall be reduced to the maximum amount permissible under applicable law; and if from any circumstance Holder shall ever receive anything of value deemed interest by applicable law in excess of the maximum amount permissible under applicable law, an amount equal to the excessive interest shall be applied to the outstanding principal balance hereof, or if such excessive amount of interest exceeds the unpaid balance of principal hereof, such excess shall be refunded to Borrower. All interest paid or agreed to be paid to Holder shall, to the extent permitted by applicable law, be amortized, prorated, allocated, and spread throughout the full period (including any renewal or extension) until payment in full of the principal so that the interest hereon for

such full period shall not exceed the maximum amount permissible under applicable law. Holder expressly disavows any intent to contract for, charge or receive interest in an amount which exceeds the maximum amount permissible under applicable law. This paragraph shall control all agreements between Borrower and Holder.

WAIVER OF JURY TRIAL. BORROWER AND PAYEE HEREBY KNOWINGLY, VOLUNTARILY AND INTELLIGENTLY WAIVE ANY AND ALL RIGHTS THAT EACH PARTY TO THIS NOTE MAY NOW OR HEREAFTER HAVE UNDER THE LAWS OF THE UNITED STATESOF AMERICA OR THE STATE OF CALIFORNIA, TO A TRIAL BY JURY OF ANY AND ALL ISSUES ARISING DIRECTLY OR INDIRECTLY IN ANY ACTION OR PROCEEDING RELATING TO THIS NOTE, THE LOAN DOCUMENTS OR ANY TRANSACTIONS CONTEMPLATED THEREBY OR RELATED THERETO. IT IS INTENDED THAT THIS WAIVER SHALL APPLY TO ANY AND ALL DEFENSES, RIGHTS, CLAIMS AND/OR COUNTERCLAIMS IN ANY SUCH ACTION OR PROCEEDING. BORROWER UNDERSTANDS THAT THIS WAIVER IS A WAIVER OF A CONSTITUTIONAL SAFEGUARD, AND EACH PARTY INDIVIDUALLY BELIEVES THAT THERE ARE SUFFICIENT ALTERNATE PROCEDURAL AND SUBSTANTIVE SAFEGUARDS, INCLUDING, A TRIAL BY AN IMPARTIAL JUDGE, THAT ADEQUATELY OFFSET THE WAIVER CONTAINED HEREIN.

IMPORTANT: READ BEFORE SIGNING. THE TERMS OF THIS AGREEMENT SHOULD BE READ CAREFULLY BECAUSE ONLY THOSE TERMS IN WRITING ARE ENFORCEABLE. NO OTHER TERMS OR ORAL PROMISES NOT CONTAINED IN THIS WRITTEN CONTRACT MAY BE LEGALLY ENFORCED. YOU MAY CHANGE THE TERMS OF THIS AGREEMENT ONLY BY ANOTHER WRITTEN AGREEMENT.

TIME IS OF THE ESSENCE HEREUNDER.

IN WITNESS WHEREOF, Borrower has caused this Note to be executed by its duly authorized representative as of the year and day first written above.

BORROWER:
NANOMETRICS INCORPORATED, a Delaware corporation
By:	/s/ Gary Schaefer

Printed Name: Gary Schaefer

Title: Chief Financial Officer

THIS DEED OF TRUST (herein “Instrument”), made and given as of July 25, 2008, by the Trustor, NANOMETRICS INCORPORATED, a Delaware corporation, successor-by-merger to Nanometrics, Inc., a California corporation, whose address is 1550 Buckeye Drive, Milpitas, California 95035-7418 (herein “Borrower”), in favor of FIRST AMERICAN TITLE COMPANY, whose address is 1737 North First Street, San Jose, California 95112, Attention: Linda Tugade (herein “Trustee”), for the benefit of the Beneficiary, GE COMMERCIAL FINANCE BUSINESS PROPERTY CORPORATION, a Delaware corporation, whose address is Middle Market Risk, 10900 Northeast Fourth Street, Suite 500, Bellevue, Washington 98004 (herein “Lender”), as beneficiary,

WITNESSETH:

THAT, WHEREAS, Borrower is justly indebted to Lender in the principal sum of $13,500,000.00, pursuant to a certain Balloon Promissory Note of even date herewith, more particularly described below,

NOW, THEREFORE, in consideration of the indebtedness herein recited and the trust herein created, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Borrower irrevocably grants, bargains, sells, conveys and assigns to Trustee, in trust, WITH POWER OF SALE, all of Borrower’s estate, right, title and interest, now owned or hereafter acquired, including any reversion or remainder interest, in the real property located in the City of Milpitas, County of Santa Clara, State of California, commonly known as 1550 Buckeye Drive, and more particularly described on Exhibit A attached hereto and incorporated herein including all heretofore or hereafter vacated alleys and streets abutting the property, and all easements, rights, appurtenances, tenements, hereditaments, rents, royalties, mineral, oil and gas rights and profits, water, water rights, and water stock appurtenant to the property (collectively “Premises”);

TOGETHER with all of Borrower’s estate, right, title, and interest, now owned or hereafter acquired, in, under, and to:

(a) all buildings, structures, improvements, parking areas, landscaping, equipment, fixtures and articles of property now or hereafter erected on, attached to, or used or adapted for use in the operation of the Premises; including but without being limited to, all heating, air conditioning, lighting, and incinerating apparatus and equipment; all boilers, engines, motors, dynamos, generating equipment, piping and plumbing fixtures, water heaters, cooling, ventilating, sprinkling and vacuum cleaning systems, fire extinguishing apparatus, gas and electric fixtures, carpeting, floor coverings, underpadding, elevators, escalators, partitions, mantels, built-in mirrors, window shades, blinds, draperies, screens, storm sash, awnings, and shrubbery and plants, and including also all interest of any owner of the Premises in any of such items hereafter at any time acquired under conditional sale contract, chattel mortgage or other title retaining or security instrument, all of which property mentioned in this clause (a) shall be deemed part of the realty covered by this Instrument and not severable wholly or in part without material injury to the freehold of the Premises (all of the foregoing together with replacements and additions thereto are referred to herein as “Improvements”); and

(b) all compensation, awards, damages, rights of action and proceeds, including interest thereon and/or the proceeds of any policies of insurance therefor, arising out of or relating to (i) a taking or damaging of the Premises or Improvements thereon by reason of any

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public or private improvement, condemnation proceeding (including change of grade), sale or transfer in lieu of condemnation, or fire, earthquake or other casualty, or (ii) any injury to or decrease in the value of the Premises or the Improvements for any reason whatsoever;

(c) return premiums or other payments upon any insurance any time provided with respect to the Premises, Improvements, and other collateral described herein for the benefit of or naming Lender, and refunds or rebates of taxes or assessments on the Premises;

(d) all written and oral leases and rental agreements (including extensions, renewals, and subleases; all of the foregoing shall be referred to collectively herein as the “Leases”) now or hereafter affecting the Premises, and including, without limitation, all rents, issues, income, profits and other revenues and income therefrom and from the renting, leasing or bailment of Improvements and equipment (“Rents”), all guaranties of tenants’ performance under the Leases (including but not limited to rights under any letter of credit given as security for such tenant’s obligations), and all rights and claims of any kind that Borrower may have against any tenant under the Leases or in connection with the termination or rejection of the Leases in a bankruptcy or insolvency proceeding;

(e) plans, specifications, contracts and agreements relating to the design or construction of the Improvements; Borrower’s rights under any payment, performance, or other bond in connection with the design or construction of the Improvements; all landscaping and construction materials, supplies, and equipment used or to be used or consumed in connection with construction of the Improvements, whether stored on the Premises or at some other location; and contracts, agreements, and purchase orders with contractors, subcontractors, suppliers, and materialmen incidental to the design or construction of the Improvements;

(f) all contracts, deposits, rights, claims or causes of action pertaining to the operation, sale or leasing of the Premises or the Improvements, including, without limitation, all options or contracts to acquire other property for use in connection with operation or development of the Premises or Improvements, management contracts, service or supply contracts, permits, licenses, franchises and certificates, and all commitments or agreements, now or hereafter in existence, intended by the obligor thereof to provide Borrower with proceeds to satisfy the loan evidenced hereby or improve the Premises or Improvements, and the right to receive all proceeds due under such commitments or agreements including refundable deposits and fees;

(g) all books, records, surveys, reports and other documents related to the Premises, the Improvements, the Leases, or other items of collateral described herein: and

(h) all additions, accessions, replacements, substitutions, proceeds and products of the real and personal property, tangible and intangible, described herein, including but not limited to lease and real-estate proceeds and other amounts relating to the use, disposition, or sale of the collateral described herein which proceeds or other amounts are characterized as general intangibles.

All of the foregoing described collateral is exclusive of any goods, inventory, equipment, furniture, furnishings, trade fixtures, and other personal property owned or supplied by Borrower or tenants of the Premises. The Premises, the Improvements, the Leases and all of the rest of the foregoing collateral are herein referred to as the “Property.”

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TO HAVE AND TO HOLD the above-described Property unto Trustee in trust for the benefit of Lender and its successors and assigns forever.

BUT THIS IS A TRUST DEED

TO SECURE TO Lender (a) the repayment of the indebtedness evidenced by that certain Balloon Promissory Note dated of even date herewith from Borrower, as maker, to Lender, as payee, in the principal sum of Thirteen Million Five Hundred Thousand and no hundredths Dollars ($13,500,000.00), with interest thereon as set forth therein, having a maturity date of August 1, 2018, and all renewals, extensions and modifications thereof (herein “Note”); (b) the repayment of any future advances, with interest thereon, made by Lender to Borrower pursuant to Section 30 hereof (herein “Future Advances”); (c) the payment of all other sums, with interest thereon, advanced in accordance herewith to protect the security of this Instrument or to fulfill any of Borrower’s obligations hereunder or under the other Loan Documents (as defined below); (d) the performance of the covenants and agreements of Borrower contained herein or in the other Loan Documents; and (e) the repayments of all sums now or hereafter owing to Lender by Borrower pursuant to any instrument which recites that it is secured hereby. The indebtedness and obligations described in clauses (a)-(e) above are collectively referred to herein as the “Indebtedness.” The Note, this Instrument, and all other documents evidencing, securing or guaranteeing the Indebtedness (except the Environmental Indemnity Agreement Regarding Hazardous Materials (“Indemnity”)), as the same may be modified or amended from time to time, are referred to herein as the “Loan Documents.” The terms of the Note secured hereby may provide that the interest rate or payment terms or balance due may be indexed, adjusted, renewed, or renegotiated from time to time, and this instrument shall continue to secure the Note notwithstanding any such indexing, adjustment, renewal or renegotiation.

Borrower represents and warrants that Borrower has good, marketable and insurable title to, and has the right to grant, convey and assign an indefeasible fee simple estate in, the Premises, Improvements, Rents and Leases and the right to convey the other Property, that the Property is unencumbered except as disclosed in writing to and approved by Lender prior to the date hereof, and that Borrower will warrant and forever defend unto Trustee the title to the Property against all claims and demands of all persons claiming by, through or under Borrower, subject only to the exceptions set forth in Schedule 1 attached hereto, the lien of taxes and assessments not yet delinquent and liens and encumbrances otherwise permitted under the Loan Documents or the Indemnity (collectively, “Permitted Exceptions”).

Borrower represents, warrants, covenants and agrees for the benefit of Lender as follows:

1. PAYMENT OF PRINCIPAL AND INTEREST. Borrower shall promptly pay when due the principal of and interest on the Indebtedness, any prepayment and other charges provided in the Loan Documents and all other sums secured by this Instrument.

2. IMPOUNDS FOR TAXES, INSURANCE AND OTHER CHARGES. Except as is hereinafter provided with respect to the impounding of such payments by Lender following the occurrence of an Event of Default, Borrower shall pay or cause to be paid when due, prior to delinquency, all annual real estate taxes, insurance premiums, assessments, water and sewer rates, ground rents and other charges (herein “Impositions”) payable with respect to

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the Property. Upon the occurrence of an Event of Default (hereinafter defined), and at Lender’s sole option at any time thereafter, Borrower shall pay in addition to each monthly payment on the Note, one-twelfth of the annual Impositions (as estimated by Lender in its sole discretion), to be held by Lender without interest to Borrower, for the payment of such Impositions (such payments being referred to herein as “Impounds”).

Annually during the term of this Instrument, if Lender shall have required Impounds following an Event of Default, Lender shall compare the Impounds collected to the Impositions paid or to be paid. If the amount of such Impounds held by Lender at such time shall exceed the amount deemed necessary by Lender to provide for the payment of Impositions as they fall due, if no Event of Default shall have occurred and be continuing, such excess shall be at Borrower’s option, either repaid to Borrower or credited to Borrower on the next monthly installment or installments of Impounds due. If at any time the amount of the Impounds held by Lender shall be less than the amount deemed necessary by Lender to pay Impositions as the fall due, Borrower shall pay to Lender any amount necessary to make up the deficiency within thirty (30) days after notice from Lender to Borrower requesting payment thereof. If an Event of Default shall have occurred and be continuing, Lender may apply, in any amount and in any order as Lender shall determine in Lender’s sole discretion, any Impounds held by Lender at the time of application (i) to pay impositions which are now or will hereafter become due, or (ii) as a credit against sums secured by this Instrument. Upon payment in full of all sums secured by this Instrument, Lender shall refund to Borrower any Impounds then held by Lender. If requested by Lender, Borrower shall promptly furnish to Lender all notices of Impositions which become due, and in the event Borrower shall make payment directly, Borrower shall promptly furnish to Lender receipts evidencing such payments.

3. APPLICATION OF PAYMENTS. Unless applicable law provides otherwise, each complete installment payment received by Lender from Borrower under the Note or this Instrument shall be applied by Lender first in payment of amounts payable to Lender by Borrower under Section 2 hereof, then to interest payable on the Note, then to principal of the Note, and then to interest and principal on any Future Advances in such order as Lender, at Lender’s sole discretion, shall determine. If an Event of Default shall have occurred and be continuing, Lender may apply, in any amount and in any order as Lender shall determine in Lender’s sole discretion, any payments received by the Lender under the Note or this instrument. Any partial payment received by Lender shall, at Lender’s option, be held in a non-interest bearing account until Lender receives funds sufficient to equal a complete installment payment.

4. CHARGES, LIENS. Borrower shall promptly discharge or bond off any lien which has, or may have, priority over or equality with, the lien of this Instrument, and Borrower shall pay, when due, the claims of all persons supplying labor or materials to or in connection with the Property. Without Lender’s prior written permission, Borrower shall not allow any lien inferior to this Instrument to be perfected against the Property. If any lien inferior to this instrument is filed against the Property without Lender’s prior written permission and without the consent of Borrower, Borrower shall, within thirty (30) days after receiving notice of the filing of such lien, cause such lien to be released of record or bonded off and deliver evidence of such release or bonding to Lender. Borrower may contest any such lien by appropriate proceedings in good faith, timely filed, provided that enforcement of the lien is stayed pending such contest. Lender may require that Borrower post security for payment of such lien.

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5. INSURANCE. Borrower shall obtain and maintain the following types of insurance upon and relating to the Property:

(a) “Special Form” property and fire insurance (with extended coverage endorsement including malicious mischief and vandalism) in an amount not less than the full replacement value of the Property (with a deductible not to exceed $10,000), naming the Lender as mortgagee under the policy and as loss payee under a lender’s loss payable endorsement and including agreed amount, inflation guard, replacement cost and waiver of subrogation endorsements;

(b) Commercial general liability insurance in an amount not less than $2,000,000 per occurrence and on an occurrence basis, insuring against personal injury, death and property damage and naming Lender as additional insured;

(c) Business interruption insurance or rent-loss insurance, as applicable covering loss of rental or other income (including all expenses by tenants) for up to twelve (12) months;

(d) Flood hazard insurance with respect to the Property in amounts not less than the maximum limit of coverage then available with respect to the Property or the amount of the Indebtedness, whichever is less if the Property is located in an area designated by the Federal Emergency Management Act or is hereafter designated or identified as an area having special flood hazards by the Department of Housing and Urban Development or such other official as shall from time to time be authorized by federal or state law to make such designation pursuant to any national or state program of flood insurance; and

(e) Such other types of insurance or endorsements to existing insurance as may be required from time to time by Lender in accordance with standard commercial lending practices for similar properties and transactions.

Upon the request of Lender, Borrower shall increase the coverages under any of the insurance policies required to be maintained hereunder or otherwise modify such policies in accordance with standard commercial lending practices for similar properties and transactions. All of the insurance policies required hereunder shall be issued by corporate insurers licensed to do business in the state in which the Property is located and having a Best’s Rating-Financial Size Rating of A:VIII or better as determined and published by A.M. Best Company, and shall be in form acceptable to Lender. Certificates of all insurance required to be maintained hereunder shall be delivered to Lender (which may include the requirement of an Acord 28 “Evidence of Property Insurance” form as to property insurance) prior to or contemporaneously with Borrower’s execution of this Instrument. All such certificates shall be in form acceptable to Lender and shall require the insurance company to give to Lender at least thirty (30) days’ prior written notice before cancelling the policy for nay reason or materially amending it. Certificates evidencing all renewal and substitute policies of insurance shall be delivered to Lender at least fifteen (15) days before termination of the policies being renewed or substituted. If any loss shall occur at any time while an Event of Default shall have occurred and shall be continuing hereunder, Lender shall be entitled to the benefit of all insurance policies held or maintained by Borrower, to the same extent as if same had been made payable to Lender, and upon foreclosure hereunder, Lender shall become the owner thereof. Lender shall have the right, but not the obligation, to make premium payments, at Borrower’s expense, to prevent any cancellation,

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endorsement, alteration or reissuance of any policy of insurance maintained by Borrower, and such payments shall be accepted by the insurer to prevent same. Lender shall have the right, in its sole and absolute discretion, upon written notice, to require Borrower furnish to Lender a copy of any insurance policy required to be carried hereunder (including endorsements), and Borrower shall furnish the requested policy or policies and all applicable endorsements within thirty (30) days of such request.

If any act or occurrence of any kind or nature (including any casualty for which insurance was not obtained or obtainable) shall result in damage to or destruction of the Property (such event being called a “Loss”), Borrower will give prompt written notice thereof to Lender. If no Event of Default has occurred hereunder and is continuing, Lender shall apply all such insurance proceeds to the restoration, replacement and rebuilding of the damaged portion of the property, and such restoration, replacement and rebuilding shall be accomplished, upon satisfaction of each and all of the following conditions: (i) except as provided in (ii) below, Lender shall be satisfied that by the expenditure of such insurance proceeds the Property will be fully restored within a reasonable period of time to its value immediately preceding the loss or damage, free and clear of all liens, except the lien of this Instrument, the Permitted Exceptions set forth in Schedule 1 attached hereto, and such other liens as are specifically approved by Lender in writing under this Instrument; (ii) in the event such proceeds shall be insufficient to restore or rebuild the Property, Borrower shall deposit promptly with Lender funds which, together with the insurance proceeds, shall be insufficient in Lender’s reasonable judgment to restore and rebuild the Property; (iii) Borrower shall make reasonable efforts to obtain a waiver of the right of subrogation from any insurer under such policies of insurance who, at that time, claims that no liability exists as to Borrower or the then owner or the assured under such policies; (iv) the excess of such insurance proceeds above the amount necessary to complete such restoration and compensate Borrower for all other insured losses shall be applied on account of the Indebtedness (first to interest, then to expenses reimbursable to Lender and then to principal amounts falling due under the Note without Prepayment Fee (as defined in the Note)); (v) Lender reviews and reasonably approves in writing the plans and specifications for the restoration work and Lender receives written evidence satisfactory to Lender that the same have been approved by all governmental authorities having jurisdiction; (vi) Borrower shall have furnished to Lender, for Lender’s approval, a detailed budget and cost breakdown for said restoration work signed by Borrower and describing the nature and type of expenses and amounts thereof estimated by Borrower for said restoration work including, but not limited to, the cost of material and supplies, architect and designer fees, general contractor’s fees, and the anticipated monthly disbursement schedule, and Lender shall have reasonably given to Borrower written approval of such budget and cost breakdown (if Borrower determines at any time that its actual expenses materially differ or will materially differ from its estimated budget, it will so advise Lender promptly); (vii) Borrower has delivered to Lender evidence satisfactory to Lender that any Credit Lease (defined below) existing at the time of the Loss will remain in full force and effect subject only to abatement of rent in accordance with the terms of the Leases until completion of such repair and restoration; and (viii) in Lender’s reasonable judgment, such restoration work can be completed at least six (6) months prior to the maturity of the Note. As used herein, the term, “Credit Lease” shall refer to a Lease on which Lender has relied either in its initial underwriting the Loan (it being acknowledged that there is no Credit Lease in effect as of the date of this Instrument) or on which Lender has relied in connection with any modification of the Loan.

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In the event any of such conditions are not or cannot be satisfied, then all of the insurance proceeds payable with respect to such Loss will be applied to the payment of the Indebtedness in such order as Lender may elect.

Under no circumstances shall Lender become obligated to take any action to restore the Property; all proceeds released or applied by Lender to the restoration of the Property pursuant to the provisions of this Section 5 shall be released and/or applied to the cost of restoration (including within the term “restoration” any repair, reconstruction or alteration) as such restoration progresses, in amounts which shall equal ninety percent (90%) of the amounts from time to time certified by an architect reasonably approved by Lender to have been incurred in such restoration of any and all of the Property (i.e., 90% of the total amount expended by the contractor for the project under a contract reasonably approved by Lender and billed by the contractor to Borrower) and performed by a contractor reasonably satisfactory to Lender and who shall furnish such corporate surety bond, if any, as may be reasonably required by Lender in accordance with the plans and specifications therefore approved by Lender and the remaining ten percent (10%) upon completion of such restoration and delivery to Lender of evidence reasonably satisfactory to Lender that no mechanics’ lien exists with respect to the work of such restoration; that the restoration work has been completed and fully paid for in accordance with plans and specifications for said work approved by Lender; and that all Credit Leases existing at the time the Loss occurred are in full force and effect with all tenants in possession and paying full Lease rental; and that all governmental approvals required for the completion of said restoration work and occupancy of the Property have been obtained and the same are in form and substance satisfactory to Lender.

If within a reasonable period of time after the occurrence of any Loss, Borrower shall not have submitted to Lender and received Lender’s approval of plans and specifications for the repair, restoration or rebuilding of such Loss or shall not have obtained approval of such plans and specifications from all governmental authorities whose approval is required, or if, after such plans and specifications are approved by Lender and by all such governmental authorities, Borrower shall fail to commence promptly such repair, restoration or rebuilding, or if thereafter Borrower fails to carry out diligently such repair, restoration or rebuilding or is delinquent in the payment to mechanics, materialmen or others of the costs incurred in connection with such work (subject to Borrower’s right to contest in good faith any claims for such costs provided that any lien for such costs is stayed pending such contest), or if any other condition of this Section 5 is not satisfied within a reasonable period of time after the occurrence of any such Loss, then Lender may, in addition to all other rights herein set forth, at Lender’s option, (A) declare that an Event of Default has occurred and/or apply all of the insurance proceeds payable with respect to such Loss to the payment of the Indebtedness in such order as Lender may elect, and/or (B) Lender, or any lawfully appointed receiver of the Property may at their respective options, perform or cause to be performed such repair, restoration or rebuilding, and may take such other steps as they deem advisable to carry out such repair, restoration or rebuilding, and may enter upon the Property for any of the foregoing purposes, and Borrower hereby waives, for itself and all others holding under it, any claim against Lender and such receiver (other than a claim based upon the alleged gross negligence or intentional misconduct of Lender or any such receiver) arising out of anything done by them or any of them pursuant to this Section 5 and Lender may in its discretion apply any proceeds held by it to reimburse itself and/or such receiver for all amounts expended or incurred by it in connection with the performance of such work, including attorneys’ fees, and any excess costs shall be paid by Borrower to Lender and Borrower’s obligation to pay such excess costs shall be secured by the lien of this Instrument and shall bear

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interest at the Default Rate set forth in the Note, until paid. Notwithstanding anything in this Instrument or any of the other Loan Documents to the contrary, Borrower shall not be required to pay any Prepayment Fee (as defined in the Note) in connection with any insurance proceeds retained by Lender.

Nothing herein, and no authority given to Borrower to repair, rebuild or restore the Property or any portion thereof, shall be deemed to constitute Borrower the agent of Lender for any purpose, or to create, either expressly or by implication, any liens or claims or rights on behalf of laborers, mechanics, materialmen or other lien holders which could in any way be superior to the lien or claim of Lender, or which could be construed as creating any third party rights of any kind or nature to the insurance funds. At reasonable times during the work of restoration, and upon reasonable notice, Lender, either personally or by duly authorized agents, shall have the right to enter upon the Property for inspection of the work. Borrower expressly assumes all risk of loss, including a decrease in the use, enjoyment or value of the Property from any casualty whatsoever, whether or not insurable or insured against.

Borrower waives any and all right to claim or recover against Lender or its officers, employees, agents and representatives, for loss of or damage to Borrower, the Property, Borrower’s property or the property of others under Borrower’s control from any cause insured against or required to be insured against under this Section 5.

6. PRESERVATION AND MAINTENANCE OF PROPERTY. Borrower (a) shall not commit waste or permit impairment or deterioration of the Property, (b) shall not abandon the Property, (c) shall restore or repair promptly and in a good and workmanlike manner all or any part of the Property to the equivalent of its original condition, or such other condition as Lender may approve in writing, in the event of any damage, injury or loss thereto, whether or not insurance proceeds are available to cover in whole or in part the costs of such restoration or repair, (d) shall keep the Property, including all Improvements thereon, in good repair and shall replace fixtures, equipment, machinery and appliances on the Property when necessary to keep such items in good repair, (e) shall comply in all material respects with all laws, ordinances, regulations and requirements of any governmental body applicable to the Property, (f) if all or part of the Property is for rent or lease, then Lender, at its option after the occurrence and during the continuance of an Event of Default, may require Borrower to provide for professional management of the Property by a property manager satisfactory to Lender pursuant to a contract approved by Lender in writing, unless such requirement shall be waived by Lender in writing (provided, however, that Lender may require such professional management following a subsequent Event of Default, even after such Event of Default shall have been cured), and (g) shall give notice in writing to Lender of and, unless otherwise directed in writing by Lender, appear in and defend any action or proceeding purporting to affect the Property, the security of this Instrument or the rights or powers of Lender hereunder. Neither Borrower nor any tenant or other person, without the written approval of Lender, shall remove, demolish or structurally alter any Improvement now existing or hereafter erected on the Premises or any Property, except when incident to the replacement of fixtures, equipment, machinery and appliances with items of like kind.

Borrower represents, warrants and covenants that the Property is and shall be in substantial compliance with the Americans with Disabilities Act of 1990 and all of the regulations promulgated thereunder, as the same may be amended from time to time.

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7. USE OF PROPERTY. Unless required by applicable law or unless Lender has otherwise agreed in writing, Borrower shall not allow changes in the use for which all or any part of the Property was intended at the time this Instrument was executed. Borrower shall not, without Lender’s prior written consent, (i) initiate or acquiesce in a change in the zoning classification (including any variance under any existing zoning ordinance applicable to the Property), (ii) permit the use of the Property to become a non-conforming use under applicable zoning ordinances, (iii) file any subdivision or parcel map affecting the Property, or (iv) materially amend, modify or consent to any easement or covenants, conditions and restrictions pertaining to the Property.

8. PROTECTION OF LENDER’S SECURITY. If an Event of Default occurs due to Borrower’s failure to perform any of the covenants and agreements contained in this Instrument, or if any action or proceeding is commenced which affects the Property or title thereto or the interest of Lender therein, including, but not limited to, eminent domain, insolvency, code enforcement, or arrangements or proceedings involving a bankrupt or decedent, then Lender at Lender’s option may make such appearances, disburse such sums and take such action as Lender deems necessary, in it sole discretion, to protect Lender’s interest, including, but not limited to, (i) disbursement of attorneys’ fees, (ii) entry upon the Property to make repairs, and (iii) procurement of satisfactory insurance as provided in Section 5 hereof.

Any amounts disbursed by Lender pursuant to this Section 8, with interest thereon, shall become additional Indebtedness of Borrower secured by this Instrument. Unless Borrower and Lender agree to other terms of payment, such amounts shall be immediately due and payable and shall bear interest from the date of disbursement at the Default Rate (as defined in the Note). Borrower hereby covenants and agrees that Lender shall be subrogated to the lien of any mortgage or other lien discharged, in whole or in part, by the Indebtedness. Nothing contained in this Section 8 shall require Lender to incur any expense or take any action hereunder.

9. INSPECTION. Lender may make or cause to be made reasonable entries upon the Property to inspect the interior and exterior thereof. Except in the case of emergency, such inspection shall be with reasonable prior notice and shall in any case be with due regard to rights of tenants and Borrower’s operations.

10. FINANCIAL DATA. Unless Borrower shall be a publicly reporting company under the Securities Exchange Act of 1934, as amended (the “1934 Act”), Borrower shall furnish to Lender, and will cause any guarantor of the Indebtedness to furnish to Lender, within one hundred twenty (120) days after the close of its fiscal year (i) annual balance sheet and profit and loss statements prepared in accordance with generally accepted accounting principles and practices consistently applied and (unless Lender shall have otherwise agreed in writing), accompanied by the annual audit report of an independent certified public accountant reasonably acceptable to Lender, (ii) an annual operating statement, together with a complete rent roll and other supporting data reflecting all material information with respect to the operation of the Property and Improvements, and (iii) all other financial information and reports that Lender may from time to time reasonably request, including, if Lender so requires, income tax returns of Borrower, and any guarantor of any portion of the Indebtedness. In addition, within one hundred twenty (120) days after the close of such tenant’s fiscal year, Borrower shall furnish to Lender the financial statements of all tenants under Credit Leases of the Property (and lease guarantors, if applicable) on whose credit Lender has relied in connection with the Loan, unless such tenant (or lease guarantor) shall be a publicly reporting company under the 1934 Act. If Borrower shall fail to provide any of the financial information described in this Section 10, Borrower shall pay to Lender an administrative fee of $250.00 per month for each month that such information remains outstanding.

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11. CONDEMNATION. If the Property, or any part thereof, shall be condemned for any reason, including without limitation fire or earthquake damage, or otherwise taken for public or quasi-public use under the power of eminent domain, or be transferred in lieu thereof, (such event being called a “Taking”) and if an Event of Default has not occurred hereunder and is not continuing, Lender shall apply all such proceeds to the restoration, replacement and rebuilding of the Property, and such restoration, replacement and rebuilding shall be accomplished, upon satisfaction of each and all of the following conditions: (i) except as provided in (ii) below, Lender shall be satisfied that by the expenditure of such proceeds the Property will be fully restored within a reasonable period of time to its value immediately preceding the Taking, free and clear of all liens, except the lien of this instrument, the Permitted Exceptions set forth in Schedule 1 attached hereto, and such other liens as are specifically approved by Lender in writing under this Instrument; (ii) in the event such proceeds shall be insufficient to restore or rebuild the Property, Borrower shall deposit promptly with Lender funds which, together with the proceeds, shall be sufficient in Lender’s reasonable judgment to restore and rebuild the Property; (iii) the excess of such proceeds above the amount necessary to complete such restoration and compensate Borrower for all other losses shall be applied on account of the Indebtedness (first to interest, then to expenses reimbursable to Lender and then to principal amounts falling due under the Note without Prepayment Fee); (iv) Lender reviews and approves in writing the plans and specifications for the restoration work and Lender receives written evidence satisfactory to Lender that the same have been approved by all governmental authorities having jurisdiction; (v) Borrower shall have furnished to Lender, for Lender’s approval, a detailed budget and cost breakdown for said restoration work signed by Borrower and describing the nature and type of expenses and amounts thereof estimated by Borrower for said restoration work including, but not limited to, the cost of material and supplies, architect and designer fees, general contractor’s fees, and the anticipated monthly disbursement schedule, and Lender shall have reasonably given to Borrower written approval of such budget and cost breakdown (if Borrower determines at any time that its actual expenses materially differ or will materially differ from its estimated budget, it will so advise Lender promptly); (vi) Borrower has delivered to Lender evidence satisfactory to Lender that all Credit Leases existing at the time of the Taking will remain in full force and effect subject only to abatement of rent in accordance with the terms of the Leases until completion of such repair and restoration; and (vii) in Lender’s reasonable judgment, such restoration work can be completed at least six (6) months prior to the maturity of the Note.

In the event any of such conditions are not or cannot be satisfied, then all of the proceeds payable with respect to such Taking will be applied to the payment of the indebtedness in such order as Lender may elect.

Under no circumstances shall Lender become obligated to take any action to restore the Property; all proceeds released or applied by Lender to the restoration of the Property pursuant to the provisions of this Section 11 shall be released and/or applied on the cost of restoration (including within the term “restoration” any repair, reconstruction or alteration) as such restoration progresses, in amounts which shall equal ninety percent (90%) of the amounts from time to time certified by an architect reasonably approved by Lender to have been incurred in such restoration of any and all of the Property (i.e., 90% of the total amount expended by the

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contractor for the project under a contract reasonably approved by Lender and billed by the contractor to Borrower) and performed by a contractor reasonably satisfactory to Lender and who shall furnish such corporate surety bond, if any, as may be reasonably required by Lender in accordance with the plans and specifications therefore approved by Lender and the remaining ten percent (10%) upon completion of such restoration and delivery to Lender of evidence reasonably satisfactory to Lender that no mechanics’ lien exists with respect to the work of such restoration; that the restoration work has been completed and fully paid for in accordance with plans and specifications for said work approved by Lender; and that all Credit Leases existing at the time the Taking occurred are in full force and effect with all tenants in possession and paying full Lease rental; and that all governmental approvals required for the completion of said restoration work and occupancy of the Property have been obtained and the same are in form and substance satisfactory to Lender.

If within a reasonable period of time after the occurrence of any Taking, Borrower shall not have submitted to Lender and received Lender’s approval of plans and specifications for the repair, restoration or rebuilding of the Property or shall not have obtained approval of such plans and specifications from all governmental authorities whose approval is required, or if, after such plans and specifications are approved by Lender and by all such governmental authorities, Borrower shall fail to commence promptly such repair, restoration or rebuilding, or if thereafter Borrower fails to carry out diligently such repair, restoration or rebuilding or is delinquent in the payment to mechanics, materialmen or others of the costs incurred in connection with such work, (subject to Borrower’s right to contest in good faith any claims for such costs provided that any lien for such costs is stayed pending such contest), or if any other condition of this Section 11 is not satisfied within a reasonable period of time after the occurrence of any such Taking, then Lender may, in addition to all other rights herein set forth, at Lender’s option, (A) declare that an Event of Default has occurred and/or apply all of the proceeds of the Taking to the payment of the Indebtedness in such order as Lender may elect, and/or (B) Lender, or any lawfully appointed receiver of the Property may at their respective options, perform or cause to be performed such repair, restoration or rebuilding, and may take such other steps as they deem advisable to carry out such repair, restoration or rebuilding, and may enter upon the Property for any of the foregoing purposes, and Borrower hereby waives, for itself and all others holding under it, any claim against Lender and such receiver (other than a claim based upon the alleged gross negligence or intentional misconduct of Lender or any such receiver) arising out of anything done by them or any of them pursuant to this Section 11 and Lender may in its discretion apply any proceeds held by it to reimburse itself and/or such receiver for all amounts expended or incurred by it in connection with the performance of such work, including attorneys’ fees, and any excess costs shall be paid by Borrower to Lender and Borrower’s obligation to pay such excess costs shall be secured by the lien of this Instrument and shall bear interest at the Default Rate set forth in the Note, until paid. Notwithstanding anything in this Instrument or any of the other Loan Documents to the contrary, Borrower shall not be required to pay any Prepayment Fee (as defined in the Note) in connection with any proceeds of any Taking retained by Lender.

Nothing herein, and no authority given to Borrower to repair, rebuild or restore the Property or any portion thereof, shall be deemed to constitute Borrower the agent of Lender for any purpose, or to create, either expressly or by implication, any liens or claims or rights on behalf of laborers, mechanics, materialmen or other lien holders which could in any way be superior to the lien or claim of Lender, or which could be construed as creating any third party rights of any kind or nature to the proceeds. At reasonable times during the work of restoration,

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and upon reasonable notice, Lender, either personally or by duly authorized agents, shall have the right to enter upon the Property for inspection of the work. Borrower expressly assumes all risk of loss, including a decrease in the use, enjoyment or value of the Property from any casualty whatsoever, whether or not insurable or insured against.

12. BORROWER AND LIEN NOT RELEASED. From time to time, Lender may, at Lender’s option, without giving notice to or obtaining the consent of the Borrower, Borrower’s successors or assigns or of any junior lienholder or guarantors, without liability on Lender’s part and notwithstanding the occurrence of an Event of Default, extend the time for payment of the Indebtedness of any part thereof, reduce the payments thereon, release anyone liable on any of the Indebtedness (including but not limited to any guarantor), accept an extension or modification or renewal note or notes therefor, modify the terms and time of payment of the Indebtedness, enter into a loan modification agreement with Borrower, release from the lien of the Instrument any part of the Property, accept or release other or additional security, reconvey any part of the Property, consent to any map or plan of the Property, consent to the granting of any easement, join in any extension or subordination agreement, and agree in writing with Borrower to modify the rate of interest or period of amortization of the Note or change the amount of the monthly installments payable thereunder. Any actions taken by Lender pursuant to the terms of this Section 12 shall not affect the obligation of Borrower or Borrower’s successors or assigns to pay the sums secured by this Instrument and to observe the covenants of Borrower contained herein, shall not affect the guaranty of any person, corporation, partnership or other entity for payment of the Indebtedness, and shall not affect the lien or priority of the lien hereof on the Property. Borrower shall pay Lender a reasonable service charge, together with such title insurance premiums and attorneys’ fees as may be incurred at Lender’s option (based on Lender’s then-current fee schedule for such matters), for any such action if taken at Borrower’s request or for other servicing requests, including but not limited to name changes, prepayments of the Indebtedness, and loan pay off statement requests. Such service charge is exclusive of any legal fees which may be incurred by Lender in connection with Borrower’s request.

13. FORBEARANCE BY LENDER NOT A WAIVER. Any forbearance by Lender in exercising any right or remedy hereunder, or otherwise afforded by applicable law, shall not be a waiver of or preclude the exercise of any other right or remedy. The acceptance by Lender of payment of any sum secured by this Instrument after the due date of such payment shall not be a waiver of Lender’s right to either require prompt payment when due of all other sums so secured or to declare a default for failure to make prompt payment (after expiration of applicable notice and cure periods). The procurement of insurance or the payment of taxes or other liens or charges by Lender shall not be a waiver of Lender’s right to accelerate the maturity of the Indebtedness secured by this Instrument, nor shall Lender’s receipt of any awards, proceeds or damages under Sections 5 and 11 hereof operate to cure or waive Borrower’s default in payment of sums secured by this Instrument.

14. CALIFORNIA COMMERCIAL CODE SECURITY AGREEMENT. This Instrument is intended to be a security agreement pursuant to the California Commercial Code for any of the items specified above as part of the Property which, under applicable law, may be subject to a security interest pursuant to the California Commercial Code, and Borrower hereby grants and conveys to Lender a first and prior security interest in all of the property that constitutes personal property (“Collateral”, for purposes of this Section 14), whether now owned or hereafter acquired. Borrower agrees that Lender may file this Instrument, or a reproduction

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thereof, in the real estate records or other appropriate index, as a financing statement for any of the items specified above as part of the Collateral. Any reproduction of this Instrument or of any other security agreement or financing statement shall be sufficient as a financing statement. In addition, Lender may submit for filing any financing statements, as well as extensions, renewals and amendments thereof, and reproductions of this Instrument in such form as Lender may deem appropriate to perfect a security interest with respect to the foregoing items. Borrower shall pay all costs of filing such financing statements and any extensions, renewals, amendments and releases thereof, and shall pay all costs and expenses of any record searches for financing statements Lender may require.

Borrower expressly warrants and covenants:

(a) Except for the security interest granted hereby and the Permitted Exceptions, Borrower is the owner of the Collateral free from any lien, security interest or encumbrance. Borrower understands that any further encumbrance of the Collateral is prohibited. Borrower shall defend the Collateral against all claims and demands of all persons at any time claiming the same or any interest therein by, through or under Borrower.

(b) The Collateral is used or bought primarily for use in the business of Borrower and not for consumer purposes.

(c) Borrower’s business address is as stated above. The Collateral is located at or on or is used or owned for or in connection with the Premises and other Property.

(d) Borrower shall promptly notify Lender of any change in the location of the Collateral or any change in Borrower’s principal place of business.

(e) Borrower shall pay when due, prior to delinquency, all taxes and assessments of every nature which may be levied or assessed against the Collateral.

(f) Except for liens in favor of Lender, without Lender’s prior written consent, Borrower shall not permit or allow any lien, security interest or encumbrance whatsoever upon the Collateral and shall not permit the Collateral to be attached or replevied. Lender’s consent to a junior lien by an entity owned by, or under common control with, Lender shall not be unreasonably withheld.

(g) The Collateral is in good condition and Borrower shall keep the Collateral in good condition (reasonable wear and tear expected) and from time to time, forthwith, replace and repair all such parts of the Collateral as may be broken, worn out, or damaged without allowing any lien to be created upon the Collateral on account of such replacement or repairs. Lender may examine and inspect the Collateral at any time, wherever located, subject to reasonable prior notice.

(h) Borrower will not use the Collateral in violation of any applicable statutes, regulations or ordinances.

Until the occurrence of an Event of Default, Borrower may have possession of the Collateral and use it in any lawful manner. If an Event of Default shall have occurred and be continuing, Lender shall have the immediate right to the possession of the Collateral.

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If an Event of Default shall have occurred and be continuing, Lender shall have the remedies of a secured party under the California Commercial Code, and Lender may also invoke the remedies provided in Section 26 of this Instrument as to such items. In exercising any of said remedies Lender may, to the extent permitted by applicable law, proceed against the items of real property and any items of Collateral specified above separately or together and in any order whatsoever, without in any way affecting the availability of Lender’s remedies under the California Commercial Code or of the remedies provided in Section 26 of this Instrument. Within ten (10) days following any request therefor by Lender, Borrower shall prepare and deliver to Lender a written inventory specifically listing all of the Collateral covered by the security interest herein granted, which inventory shall be certified by Borrower as being true, correct, and complete.

FIXTURE FILING. Portions of the Collateral are goods which are or are to become fixtures relating to the Property, and Borrower covenants and agrees that the filing of this Instrument in the real estate records of the county where the Property is located shall also operate from the time of filing as a fixture filing in accordance with Section 9502(c) of the California Commercial Code.

FIXTURE FILING. The following information is provided in order that this Instrument shall comply with the requirements of the Uniform Commercial Code, as enacted in the State where the Premises are located, for instruments to be filed as financing statements and with other requirements of applicable law:

(a)     Name of Borrower (Debtor):	NANOMETRICS INCORPORATED
Type of Organization:	corporation
Address of Borrower:	1550 Buckeye Drive
	Milpitas, California 95035-7418
Jurisdiction of Borrower’s Organization:	Delaware
Borrower’s Organizational ID No.	3913131
(b)     Name of Lender (Secured Party):	GE COMMERCIAL FINANCE BUSINESS PROPERTY CORPORATION
Address of Lender:	10900 Northeast Fourth Street, Suite 500
	Bellevue, Washington 98004
	Attention: Middle Market Risk
(c)     Record Owner of Real Estate Described on Exhibit A hereto:	BORROWER

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15. LEASES OF THE PROPERTY. As used in this Section 15, the word “Lease” shall include subleases. Borrower shall comply with and observe Borrower’s obligations as landlord under all Leases of the Property or any part thereof. All Leases now or hereafter entered into will be in form and substance subject to the approval of Lender based on Lender’s then-current underwriting criteria for similar properties and transactions. That certain Lease between Borrower and Master Kraft Machining, Inc., a California corporation, date November 12, 2007 (“Master Kraft Lease”), has been approved by Lender and Lender agrees that the Master Kraft Lease is not a Credit Lease. Borrower shall pay all attorneys’ fees incurred by Lender in reviewing any Lease or proposed Lease. All Leases of the Property shall specifically provide that such Leases are subordinate to this Instrument; that the tenant attorns to Lender, such attornment to be effective upon Lender’s acquisition of title to the Property; that the tenant agrees to execute such further evidences of attornment as Lender may from time to time request; that the attornment of the tenant shall not be terminated by foreclosure; and that Lender may, at Lender’s option, accept or reject such attornments (except as to third-party credit tenants unrelated to Borrower, as to which lender shall grant a non-disturbance provision). Borrower shall not, without Lender’s written consent, request or consent to the subordination of any Lease of all or any part of the Property to any lien subordinate to this Instrument. If Borrower becomes aware that any tenant under a Credit Lease proposes to do, or is doing, any act or thing which may give rise to any right of set-off against rent, Borrower shall (i) take such steps as shall be reasonably calculated to prevent the accrual of any right to a set-off against rent, (ii) immediately notify Lender thereof in writing and of the amount of said set-offs, and (iii) within ten (10) days after such accrual, reimburse the tenant who shall have acquired such right to set-off or take such other steps as shall effectively discharge such setoff and as shall assure that Rents thereafter due shall continue to be payable without set-off or deduction. Upon Lender’s receipt of notice of the occurrence of any material default or violation by Borrower of any of its obligations under the Leases beyond applicable periods for notice and cure, Lender shall have the immediate right, but not the duty or obligation, without prior written notice to Borrower or to any third party (but with due regard for rights of tenants under Leases), to enter upon the Property and to take such actions as Lender may deem necessary to cure the default or violation by Borrower under the Leases. The costs incurred by Lender in taking any such actions pursuant to this paragraph shall become part of the Indebtedness, shall bear interest at the Default Rate provided in the Note, and shall be payable by Borrower to Lender on demand. Lender shall have no liability to Borrower or to any third party for any actions taken by Lender or not taken pursuant to this paragraph.

16. REMEDIES CUMULATIVE. Each remedy provided in this Instrument is distinct and cumulative to all other rights or remedies under this Instrument or afforded by law or equity, and may be exercised concurrently, independently, or successively, in any order whatsoever.

17. TRANSFERS OF THE PROPERTY OR BENEFICIAL INTERESTS IN BORROWER; SUBORDINATE FINANCING PROHIBITED; ASSUMPTION. Lender may, at its option, declare all sums secured by this Instrument to be immediately due and payable, and Lender may invoke any remedies permitted by Section 26 of this Instrument, if title to the Property is changed without the prior written consent of Lender, which consent shall be at Lender’s sole discretion. Any transfer of any interest in the Property or in the income therefrom, by sale, lease (except for Leases to tenants in the ordinary course of managing income property which are approved by lender pursuant to Section 15 of this Instrument), contract, mortgage, deed of trust, further encumbrance or otherwise (including any such transfers as security for additional financing of the Property), and any change in the majority ownership interest in

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Borrower (including any transfer, pledge, assignment, or hypothecation thereof), shall be considered a change of title, except changes in ownership resulting from transfers to the parents, spouses, siblings, and/or lineal descendents of the current owner(s) of such interests upon the death of the current owner[s]. Leasehold deeds of trust and collateral assignments of any Lease of the Property given by tenants of the Property are prohibited without the prior written consent of Lender, which consent may be withheld in Lender’s sole discretion. Notwithstanding the foregoing, additional but subordinate deeds of trust may be granted to Lender and, subject to the prior written consent of Lender, which consent may be withheld in Lender’s sole discretion, may be granted to entities owned by or under common control with Lender.

Lender shall have the right to condition its consent to any proposed sale or transfer described in this Section 17 upon, among other things, Lender’s approval of the transferee’s creditworthiness and management ability, and the transferee’s execution, prior to the sale or transfer, of a written assumption agreement containing such terms as Lender may require, including, if required by Lender, the imposition of an assumption fee of one percent (1%) of the then outstanding balance of the Indebtedness. Consent by Lender to one transfer of the Property shall not constitute consent to subsequent transfers or waiver of the provisions of this Section 17. No transfer by Borrower shall relieve Borrower of liability for payment of the Indebtedness, unless Lender shall otherwise agree in writing at the time of such transfer. Borrower shall pay any recording tax, recording cost, title insurance premium, attorneys’ fees, or other third-party expenses incurred by Lender in connection with any transfer, whether or not consent is required.

Notwithstanding the foregoing, Lender acknowledges that Borrower is a publicly-held company and that purchases and sales of its common stock from time to time on a generally recognized United States Stock exchange or national market system and in the ordinary course of business shall not constitute a transfer of the Property or a change in the direct or indirect ownership interest in Borrower for purposes of this Section 17. Further, offerings and sales of additional securities of Borrower, payment of stock dividends, redemptions of stock, issuance of securities pursuant to stock options, bonus or incentive plans or other common uses of publicly traded securities shall not be considered to be changes in the direct or indirect ownership interests in Borrower under this Section 17.

The transfer to and assumption by an approved transferee of the Borrower’s obligations under the Loan shall not constitute a “prepayment” of the Loan requiring payment of a “Prepayment Fee” (as defined in the Note).

18. NOTICE. Except for any notice required under applicable law to be given in another manner, any and all notices, elections, demands, or requests permitted or required to be made under this Instrument or under the Note shall be in writing, signed by the party giving such notice, election, demand or request, and shall be delivered personally, or sent by registered, certified, or Express United States mail, postage prepaid, or by Federal Express or similar nationally recognized delivery service requiring a receipt, to the other party at the address stated above, or to such other party and at such other address within the United States of America as any party may designate in writing as provided herein. The date of receipt of such notice, election, demand or request shall be the earliest of (i) the date of actual receipt, (ii) three (3) business days after the date of mailing by registered or certified mail, (iii) one (1) business day after the date of sending via overnight delivery by Express Mail, Federal Express, or another similar service requiring a receipt, or (iv) the date of personal delivery (or refusal by or on behalf of the addressee upon presentation for delivery of a properly addressed notice).

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19. SUCCESSORS AND ASSIGNS BOUND; JOINT AND SEVERAL LIABILITY; AGENTS; CAPTIONS. The covenants and agreements herein contained shall bind, and the rights hereunder shall injure to, the respective heirs, successors and assigns of Lender and Borrower, subject to the provisions of Section 17 hereof. If Borrower is comprised of more than one person or entity, whether as individuals, partners, partnerships, limited liability companies, or corporation, each such person or entity shall be jointly and severally liable for Borrower’s obligations hereunder. In exercising any rights hereunder or taking any actions provided for herein, Lender may act through its employees, agents or independent contractors as authorized by Lender. The captions and headings of the sections of this Instrument are for convenience only and are not to be used to interpret or define the provisions hereof.

20. WAIVER OF STATUTE OF LIMITATIONS. Borrower hereby waives the right to assert any statute of limitations as a bar to the enforcement of the lien of this Instrument or to any action brought to enforce the Note or any other obligation secured by this Instrument.

21. WAIVER OF MARSHALLING. Notwithstanding the existence of any other security interests in the Property held by Lender or by any other party, Lender shall have the right to determine the order in which any or all of the Property shall be subjected to the remedies provided herein. Lender shall have the right to determine the order in which any or all portions of the Indebtedness secured hereby are satisfied from the proceeds realized upon the exercise of the remedies provided herein. Borrower, any party who consents to this Instrument and any party who now or hereafter acquires a security interest in the Property and who has actual or constructive notice hereof hereby waives any and all right to require the marshalling of assets in connection with the exercise of any of the remedies permitted by applicable law or provided herein.

22. HAZARDOUS WASTE. Lender has obtained and Borrower has reviewed a Phase I Environmental Site Assessment date October 26, 2007, prepared by Eras Environmental, Inc. (the “Report”). Except as disclosed to Lender in the Report or otherwise previously disclosed to Lender, Borrower has received no notification and has no actual knowledge of any kind suggesting that the Property or any adjacent property is or may be contaminated with any hazardous waste or materials or is or may be required to be cleaned up in accordance with any applicable law or regulation; and Borrower further represents and warrants that, except as previously disclosed to Lender in writing, to the best of its actual knowledge as of the date hereof, there are no hazardous waste or materials located in, on or under the Property or any adjacent property, or incorporated in and Improvements, nor has the Property or any adjacent property ever been used as a landfill or a waste disposal site, or a manufacturing, handling, storage, distribution or disposal facility for hazardous waste or materials, except for reasonable quantities of ordinary office supplies, cleaning supplies, insecticides, pesticides, and paint used in the normal operation and maintenance of the Property and any other substances or materials used by borrower or tenants of the Property in the design or manufacture of process control metrology systems, provided that the same are used, stored, handled, and disposed of in accordance with applicable laws (“Permitted Substances”). As used herein, the term “hazardous waste or materials” includes any substance or material defined in or designated as hazardous or toxic wastes, hazardous or toxic materials, a hazardous, toxic or radioactive substance, or other similar term, by any federal, state or local statute, regulation and ordinance now or hereafter in effect. Borrower shall promptly comply with all statutes, regulations and ordinances, and with

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all orders, decrees or judgments of governmental authorities or courts having jurisdiction, relating to the use, collection, treatment, disposal, storage, control, removal or cleanup of hazardous waste or materials in, on or under the Property or incorporated in any Improvements, at Borrower’s expense. In the event that Lender at any time has reason to believe that the Property is not free of all hazardous waste or materials other than Permitted Substances or that Borrower has violated any applicable environmental law with respect to the Property, then immediately, upon request by Lender, Borrower shall promptly order, diligently pursue obtaining and furnish to Lender, at Borrower’s sole cost and expense, an environmental audit and inspection of the Property from an expert satisfactory to Lender. In the event that Borrower fails to immediately obtain such audit or inspection, Lender or its agents may perform or obtain such audit or inspection at Borrower’s sole cost and expense. Lender may, but is not obligated to, enter upon the Property and take such actions and incur such costs and expenses to effect such compliance as it deems advisable to protect its interest in the Property; and whether or not Borrower has actual knowledge of the existence of hazardous waste or materials on the Property or any adjacent property as of the date hereof, Borrower shall reimburse Lender as provided in Section 23 below for the full amount of all costs and expenses incurred by Lender prior to Lender acquiring title to the Property through foreclosure or acceptance of a deed in lieu of foreclosure or such earlier time as Lender obtains control of the Property, in connection with such compliance activities. Neither this provision nor any of the other Loan Documents shall operate to put Lender in the position of an owner of the Property prior to any acquisition of the Property by Lender. The rights granted to Lender herein and in the other Loan Documents are granted solely for the protection of Lender’s lien and security interest covering the Property, and do not grant to Lender the right to control Borrower’s actions, decisions or policies regarding hazardous waste or materials.

In the event that nay portion of the property is determined to be “environmentally impaired” (as “environmentally impaired” is defined in California Code of Civil Procedure Section 726.5(e)(3)) or to be an “affected parcel” (as “affected parcel” is defined in California Code of Civil Procedure Section 726.5(e)(1)), then, without otherwise limiting or in any way affecting Lender’s or Trustee’s rights and remedies under this Instrument upon the occurrence and during the continuance of an Event of Default, Lender may elect to exercise its right under California Code of Civil Procedure Section 726.5(a) to (1) waive it lien on such environmentally impaired or affected parcel portion of the Property and (2) exercise (i) the rights and remedies of an unsecured creditor, including reduction of its claim against Borrower to judgment, and (ii) any other rights and remedies permitted by law. For purposes of determining Lender’s right to proceed as an unsecured creditor under California Code of Civil Procedure Section 726.5(a), Borrower shall be deemed to have a willfully permitted or acquiesced in a release or threatened release of hazardous materials, within the meaning of California Code of Civil Procedure Section 726.5(d)(1), if the release or threatened release of hazardous materials was knowingly or negligently cause or contributed to by any lessee, occupant or user which caused or contributed to the release or threatened release. All costs and expenses, including, but not limited to, attorneys’ and paralegals’ fees and costs and court costs incurred by Lender in connection with any action commenced under this Section 22, including any action required by California Code of Civil Procedure Section 726.5(b) to determine the degree to which the Property is environmentally impaired, plus interest thereon at the Default Rate specified in the note, provided that such interest rate shall not exceed the maximum interest rate permitted by law, until paid, shall be added to the Indebtedness secured by this Instrument and shall be due and payable to Lender upon its demand made at any time following the conclusion of such action.

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23. ADVANCES, COSTS AND EXPENSES. Borrower shall pay within ten (10) days after written demand from lender all sums advanced by Lender and all costs and expenses incurred by lender in taking any actions pursuant to the Loan Documents including attorneys’ fees and disbursements, accountants’ fees, appraisal and inspection fees and the costs for title reports and guaranties, together with interest thereon at the rate applicable under the Note after and Event of Default from the date such costs were advanced or incurred. All such costs and expenses incurred by Lender, and advances made, shall constitute advances under this Instrument to protect the Property and shall be secured by and have the same priority as the lien of this Instrument. If Borrower fails to pay any such advances, costs and expenses and interest thereon, to the extent permitted by applicable law, Lender may apply any undisbursed loan proceeds to pay the same, and, without foreclosing the lien of this Instrument, may at its option commence an independent action against Borrower for the recovery of the costs, expenses and/or advances, with interest, together with costs of suit, costs of title reports and guaranty of title, disbursements of counsel and reasonable attorneys’ fees incurred therein or in any appeal therefrom. If any check delivered by or on behalf of Borrower in payment of any monthly installment due on the Indebtedness or any other payment due hereunder shall be returned on account of insufficient funds, or if Lender is unable to debit Borrower’s account for such payment in accordance with previously agreed automated funds withdrawal mechanism, Borrower shall pay a service charge in accordance with Lender’s the-current fee schedule.

24. ASSIGNMENT OF LEASES AND RENTS. Borrower, for good and valuable consideration, the receipt of which is hereby acknowledged, to secure the Indebtedness, does hereby absolutely and unconditionally grant, bargain, sell, transfer, assign, convey, set over and deliver unto Lender all right, title and interest of Borrower in, to and under the Leases of the Property, whether now in existence or hereafter entered into, and all guaranties, amendments, extensions and renewals of said Leases and any of them, and all Rents which may now or hereafter be or become due or owing under the Leases, and any of them, or on account of the use of the Property.

Borrower represents, warrants, covenants and agrees with Lender as follows:

(a) The sole ownership of the entire lessor’s interest in the Leases is vested in Borrower, and Borrower has not, and shall not, perform any acts or execute any other instruments which might prevent Lender from fully exercising its rights with respect to the Leases under any of the terms, covenants and conditions of this Instrument.

(b) Credit Leases shall not be altered, modified, amended, terminated, canceled, renewed or surrendered except as approved in writing by Lender, which approval shall not be unreasonably withheld or delayed, subject to Lender’s then-current underwriting criteria for similar properties and transactions. The terms and conditions of any Credit Leases shall not be waived in any manner whatsoever except as approved in writing by Lender, which approval shall not be unreasonably withheld or delayed, subject to Lender’s then-current underwriting criteria for similar properties and transactions.

(c) Without limiting the foregoing: Borrower shall not decrease the term or the amount of rent payable under any Credit Lease or amend the provisions in any Credit Lease regarding assignment or subletting without prior written notice to Lender and Lender’s consent.

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(d) There are not defaults now existing under any Credit Lease, and, to the best of Borrower’s actual knowledge, there exists no state of facts which, with the giving of notice or lapse of time or both, would constitute a default under any Credit Lease.

(e) Borrower shall give prompt written notice to Lender of any notice received by Borrower claiming that a default has occurred under any Credit Lease on the part of Borrower, together with a complete copy of any such notice.

(f) Each Credit Lease shall remain in full force and effect irrespective of any merger of the interest of lessor and any lessee under any Credit Lease.

(g) Borrower will not permit any Credit Lease to become subordinate to any lien other than the lien of this Instrument.

(h) Borrower shall not permit the assignment of the lessee’s interest under any Credit Lease without Lender’s prior written consent, which consent shall not be unreasonably withheld or delayed, subject to Lender’s then-current underwriting criteria for similar properties and transactions.

The assignment made hereunder is an absolute, present assignment from Borrower to Lender, effective immediately, and is not merely an assignment for security purposes but is irrevocable by Borrower so long as the Indebtedness remains outstanding. Notwithstanding the foregoing, until a notice is sent to the Borrower in writing that an Event of Default (as defined below) has occurred under the terms and conditions of the Note or any instrument constituting security for the Note (which notice is hereafter called a “Notice”), Borrower is granted a license to receive, collect and enjoy the Rents accruing from the Property.

If and Event of Default shall occur, Lender may, at it option, after service of a Notice, receive and collect all such Rents as they become due, from the Property. Lender shall thereafter continue to receive and collect all such Rents, until Lender shall otherwise agree in writing. All sums received by Borrower after service of such Notice shall be deemed received in trust and shall be immediately turned over to Lender.

Borrower hereby irrevocably appoints Lender its true and lawful attorney-in-fact with power of substitution and with full power for Lender in its own name and capacity or in the name and capacity of Borrower, from and after service of Notice, to demand, collect, receive and give complete acquittances for any and all Rents accruing form the Property, either in its own name or in the name of Borrower or otherwise, which Lender may deem necessary or desirable in order to collect and enforce the payment of the Rents and to demand, correct, receive, endorse, and deposit all checks, drafts, money orders or notes given in payment of such Rents. Such appointment is coupled with and interest and is irrevocable. Lender shall not be liable for or prejudiced by any loss of any note, checks, drafts, etc., unless such loss is found by a court of competent jurisdiction to have been due to the gross negligence or willful misconduct of Lender.

If Lender shall have sent a Notice and shall be collecting Rents under this Section 23, Lender shall apply the Rents received from Borrower’s lessees to accrued interest and principal under the Note. If no Event of Default remains uncured, amounts received in excess of the aggregate monthly payment due under the Note shall be remitted to Borrower in a timely manner. Nothing contained herein shall be construed to constitute Lender as a mortgage-in-possession in absence of its physically taking possession of the Property.

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Borrower also hereby irrevocably appoints Lender from and after service of a Notice as its true and lawful attorney-in-fact to appear in any state or federal bankruptcy, insolvency, or reorganization proceeding in any state or federal court involving any of the tenants of the Leases. Lessees of the Property are hereby expressly authorized and directed, from and after service of a Notice to pay any and all amounts due Borrower pursuant to the Leases to Lender or such nominee as Lender may designate in writing delivered to and received by such lessees who are expressly relieved of any and all duty, liability or obligation to Borrower in respect of all payments so made.

If an Event of Default shall occur, Lender is hereby vested with full power from and after service of a Notice to use all measures, legal and equitable, to the extent permitted by applicable law, deemed by it necessary or proper to enforce the assignment granted hereunder and to collect the Rents assigned hereunder, including the right of Lender or its designee, to enter upon the Property, or any part thereof, and take possession of all or any part of the Property together with all personal property, fixtures, documents, books, records, papers and accounts of Borrower relating thereto, and may exclude the Borrower, its agents and servants, wholly therefrom, but only to the extent permitted by and in accordance with applicable law. Borrower hereby grants full power and authority to Lender to exercise all rights, privileges and powers herein granted at any and all times after service of a Notice, with full power to use and apply all of the Rents and other income herein assigned to the payment of the costs of managing and operation the Property and of any indebtedness or liability of Borrower to Lender, including but not limited to the payment of taxes, special assessments, insurance premiums, damage claims, the costs of maintaining, repairing, rebuilding and restoring the Improvements on the premises or of making the same rentable, reasonable attorneys’ fees incurred in connection with the enforcement of the assignment granted hereunder, and of principal and interest payments due from Borrower to Lender on the Note and this Instrument, all in such order as Lender may determine. Lender shall be under no obligation to exercise or prosecute any of the rights or claims assigned to it hereunder or to perform or carry out any of the obligations of the lessor under any of the Leases and does not assume any of the liabilities is connection with or arising or growing out of the covenants and agreements of Borrower in the Leases. It is further understood that the assignment granted hereunder shall not operate to place responsibility for the control, care, management or repair of the Property, or parts thereof, upon Lender, not shall it operate to make Lender liable for the performance of any of the terms and conditions of any of the Leases, or for any waste of the Property by any lessee under any of the Leases or any other person, or for any dangerous or defective condition of the Property or for any negligence in the management, upkeep repair or control of the Property resulting in loss or injury or death to any lessee, licensee, employee or stranger, unless the same shall have been found by a court of competent jurisdiction to have been due to the gross negligence or willful misconduct of Lender.

25. DEFAULT. The following shall each constitute an event of default (“Event of Default”):

(a) The occurrence of an “Event of Default” under the Note.

(b) Failure of Borrower within the time required by this instrument to make any payment for taxes, insurance or for reserves for such payments, or any other payment necessary to prevent filing of or discharge of any lien, and such failure shall continue for a period of ten (10) days after written notice is given to Borrower by Lender specifying such failure.

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(c) Failure by Borrower or any guarantor of the Loan to observe or perform its obligations to Lender on or with respect to any transactions, debts, undertakings or agreements other than the transaction evidenced by the Note, following the giving of any notice required thereunder and/or the expiration of any applicable period of grace provided thereby.

(d) Failure of Borrower to make any payment or perform any obligation under any superior liens or encumbrances on the Property, within the time required thereunder, or commencement of any suit or other action to foreclose any superior liens or encumbrances.

(e) Failure by Borrower to observe or perform any of its obligations under any Credit Lease, following the giving of any notice required thereunder and/or the expiration of any applicable period of grace provided thereby.

(f) The Property is transferred or any agreement to transfer any part or interest in the Property in any manner whatsoever (other than an agreement that contemplates payment of the Indebtedness in full upon consummation of such agreement) is made or entered into without the prior written consent of Lender, except as specifically allowed under this Instrument, including without limitation creating or allowing any liens on the Property or leasing any portion of the Property.

(g) Filing by Borrower of a voluntary petition in bankruptcy or filing by Borrower of any petition or answer seeking or acquiescing in any reorganization, arrangement, composition, readjustment, liquidation, or similar relief for itself under any present or future federal, state or other statute, law or regulation relating to bankruptcy, insolvency or other relief for debtors, or the seeking, consenting to, or acquiescing by Borrower in the appointment of any trustee, receiver, custodian, conservator or liquidator for Borrower, any part of the Property, or any of the Rents of the Property, or the making by Borrower of any general assignment for the benefit of creditors, or the inability of or failure by Borrower to pay its debts generally as they become due, or the insolvency on a balance sheet basis or business failure of borrower, or the making or suffering of a preference within the meaning of federal bankruptcy law or the making of a fraudulent transfer under applicable federal or state law, or concealment by Borrower of any of its property in fraud of creditors, or the imposition of a lien upon any of the property of Borrower which is not discharged in the manner permitted by Section 4 of this Instrument, or the giving of notice by Borrower to any governmental body of insolvency or suspicion of operations.

(h) Filing a petition against Borrower seeking any reorganization, arrangement, composition, readjustment, liquidation, or similar relief under any present or future federal, state or other law or regulation relating to bankruptcy, insolvency or other relief for debts, or the appointment of any trustee, receiver, custodian, conservator or liquidator of Borrower, of any part of the Property or of any of the Rents of the Property, unless such petition shall be dismissed within sixty (60) days after such filing, but in any event prior to the entry of an order, judgment or decree approving such petition.

(i) The institution of any proceeding for the dissolution or termination of Borrower voluntarily, involuntarily, or by operation of law, unless such proceeding shall be dismissed within sixty (60) days after such filing, but in any event prior to the entry of an order, judgment or decree for relief, or the death or legal adjudication of incompetence of Borrower.

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(j) A material adverse change occurs in the assets, liabilities or net worth of Borrower from the assets, liabilities or net worth of Borrower previously disclosed to Lender.

(k) Any material warranty, representation or statement furnished to Lender by or on behalf of Borrower under the Note, this instrument, any of the other Loan Documents of the Indemnity, shall prove to have been false or misleading in any material respect when made.

(l) Failure of Borrower to observe or perform any other covenant or condition contained herein and such default shall continue for thirty (30) days after notice is given to Borrower specifying the nature of the failure, or if the default cannot be cured within such applicable cure period, Borrower fails within such time to commence and pursue curative action with reasonable diligence or fails at any time after expiration of such applicable cure period to continue with reasonable diligence all necessary curative actions; provided, however, that no notice of default and no opportunity to cure shall be required with respect to defaults under Section 17 hereof or if during the prior twelve (12) months Lender has already sent more than one (1) notice to Borrower concerning default in performance of the same obligation.

(m) Failure of Borrower to observe or perform any other obligation Under any other Loan Document or the Indemnity when such observance or performance is due, and such failure shall continue beyond the applicable cure period set forth in such Loan Document, or if the default cannot be cured within such applicable cure period, Borrower fails within such time to commence and pursue curative action with reasonable diligence or fails at any time after expiration of such applicable cure period to continue with reasonable diligence all necessary curative actions. No notice of default and no opportunity to cure shall be required if during the prior twelve (12) months Lender has already sent more than one (1) notice to Borrower concerning default in performance of the same obligation.

(n) Borrower’s abandonment of the Property, or the termination before the end of the stated term of any Credit Lease.

(o) Any of the events specified in (g) – (j) above shall occur with Respect to any tenant under a Credit Lease of the Property or with respect to any guarantor of any tenant’s obligations relating to the Property.

(p) Any of the events specified in (g) – (j) above shall occur with respect to any guarantor of any of Borrower’s obligations in connection with the Indebtedness or such guarantor dies or is declared legally incompetent.

26. RIGHTS AND REMEDIES ON DEFAULT.

26.1 Remedies. Upon the occurrence of any Event of Default and at any time thereafter, Trustee or Lender may exercise any one or more of the following rights and remedies:

(a) Lender may declare all sums secured by this Instrument Immediately due and payable, including any Prepayment Fee which Borrower would be required to pay.

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(b) The Trustee shall have the right to foreclose by notice and sale, or lender shall have the right to foreclose by judicial foreclosure, in either case in accordance with applicable law.

(c) In the event of any foreclosure, to the extent permitted by applicable law, Lender will be entitled to a judgment which will provide that if the foreclosure sale proceeds are insufficient to satisfy the judgment, execution may issue for any amount by which the unpaid balance of the obligations secured by this instrument exceeds the net sale proceeds payable to Lender.

(d) With respect to all or any part of the Property that constitutes personal property, Lender shall have all rights and remedies of secured party under the California Commercial Code.

(e) Lender shall have the right to petition to have a receiver appointed to take possession of any or all of the Property, with the power to protect and preserve the Property, to operate the Property preceding foreclosure or sale, to collect all the Rents from the Property and apply the proceeds, over and above cost of the receivership, against the sums due under this Instrument, and to exercise all of the rights with respect to the Property described in Section 24 above. The receiver may serve without bond if permitted by law. Lender’s right to the appointment of a receiver shall exist whether or not apparent value of the Property exceeds the sums due under his Instrument by a substantial amount. Employment by Lender shall not disqualify a person from serving as a receiver.

(f) In the event Borrower remains in possession of the Property after the property is sold as provided above or Lender otherwise becomes entitled to possession of the Property upon default of Borrower, Borrower shall become a tenant at will of Lender or the purchaser of the Property and shall pay a reasonable rental for use of the Property while in Borrower’s possession.

(g) Trustee and Lender shall have any other right or remedy provided in this instrument, the Note, or any other Loan Document or instrument delivered by Borrower in connection therewith, or available at law, in equity or otherwise.

(h) Lender shall have all the rights and remedies set forth in Sections 23 and 24.

26.2 Sale of the Property. In exercising its rights and remedies, the Trustee or Lender may, at Lender’s sole discretion, cause all or any part of the Property to be sold as a whole or in parcels, and certain portions of the Property may be sold without selling other portions. Lender may bid at any public sale on all or any portion of the Property.

(a) If at the time of the sale the said Trustee, or the one acting, shall deem it best for any reason to postpone or continue said sale for one or more days, they or he may do so, in which event notice of such postponement or continuance shall be made in such manner as the Trustee, or the one acting, may deem sufficient under the laws of the state in which the Premises are located.

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(b) At any such public sale, Trustee may execute and deliver to the purchaser a conveyance of the Property or any part of the Property in fee simple by Trustee’s deed and, to this end to the extend permitted by applicable law, Borrower hereby constitutes and appoints Trustee the agent and attorney-in-fact of Borrower to make such sale and conveyance, and thereby to divest Borrower of all right, title or equity that Borrower may have in and to the Property and to vest the same in the purchaser or purchasers at such sale or sales. Said appointment is coupled with an interest and shall be irrevocable.

(c) Upon any public sale pursuant to the aforementioned power of sale and agency, the proceeds of said sale shall be applied as provided by law. In the event that such proceeds are insufficient to pay all costs and expenses of sale, Lender may advance such sums as it in its sole and absolute discretion shall determine for the purpose of paying all or any part of such costs and expenses, and all such sums shall be a part of the indebtedness, payable on demand with interest at the Default Rate provided in the Note. Subject to the limitations on recourse set forth in the Note and subject to the applicable provisions of California law, Borrower shall remain liable for any deficiency resulting if the proceeds of sale are inadequate to repay the indebtedness.

26.3 Notice of Sale. Lender shall give Borrower reasonable notice of the time and place of any public sale of any personal property or of the time after which any private sale or other intended disposition of the personal property is to be made. Reasonable notice shall mean notice given in accordance with applicable law, including notices given in the manner and at the times required for notices in nonjudicial foreclosure.

26.4 Waiver; Election of Remedies. A waiver by either party of a breach of a provision of this instrument shall not constitute a waiver of or prejudice the party’s right otherwise to demand strict compliance with that provision or any other provision. Election by Lender to pursue any remedy shall not exclude pursuit of any other remedy, and all remedies of Lender under this instrument are cumulative and not exclusive. An election to make expenditures or take action to perform an obligation of Borrower shall not affect Lender’s right to declare a default and exercise its remedies under this instrument.

27. RECONVEYANCE. Upon payment of all sums secured by this instrument, lender shall request Trustee to reconvey the Property and shall surrender this instrument and all notes evidencing indebtedness secured by this instrument to Trustee. Trustee shall reconvey the Property without warranty to the person or persons legally entitled thereto. Such person or persons shall pay Trustee’s costs incurred in so reconveying the Property.

28. PROVISIONS REGARDING TRUSTEE. Trustee shall not be liable for any error of judgment or act done by Trustee, or be otherwise responsible or accountable under any circumstances whatsoever. Trustee shall not be personally liable in case of entry by it or anyone acting by virtue of the powers herein granted it upon the Property for debts contracted or liability or damages incurred in the management or operation of the Property. All monies received by Trustee shall, until used or applied as herein provided, be held in trust for the purposes for which they were received, but need not be segregated in any manner from any other monies (except to the extent required by law) and Trustee shall be under no liability for interest on any monies received by it hereunder.

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Trustee may resign by giving of notice of such resignation in writing to Lender. If Trustee shall die, resign or become disqualified from acting, or shall fail or refuse to exercise its powers hereunder when requested by Lender so to do, or if any reason and without cause Lender shall prefer to appoint a substitute trustee to act instead of the original Trustee named herein, or any prior successor or substitute trustee, Lender shall have full power to appoint a substitute trustee and, if preferred, several substitute trustees in succession who shall succeed to all the estate, rights, powers and duties of the forenamed Trustee. Upon appointment by Lender and upon recording of the substitution in the land records of the city or county in which the Premises are located, any new Trustee appointed pursuant to any of the provisions hereof shall, without any further act, deed or conveyance, become vested with all the estates, properties, rights, powers and trusts of its predecessor in the rights hereunder with the same effect as if originally named as Trustee herein.

29. USE OF PROPERTY. The Property is not currently used for residential, agricultural, farming, timber or grazing purposes. Borrower warrants that this instrument is and will at all times constitute a commercial trust deed, as defined under appropriate state law.

30. FUTURE ADVANCES. Upon request of Borrower, Lender, at Lender’s option so long as this instrument secures Indebtedness held by Lender, may make Future Advances to Borrower. Such Future Advances, with interest thereon, shall be secured by this Instrument when evidenced by promissory notes stating that said notes are secured hereby.

31. IMPOSITION OF TAX BY STATE.

31.1 State Taxes Covered. The following constitute state taxes to which this Section applies:

(a) A specific tax upon trust deeds or upon all or any part of the indebtedness secured by a trust deed.

(b) A specific tax on a grantor which the taxpayer is authorized or required to deduct from payments on the indebtedness secured by a trust deed.

(c) A specific tax on a trust deed chargeable against the beneficiary or the holder of the note secured.

(d) A specific tax on all or any portion of the indebtedness or on payments of principal and interest made by a grantor.

31.2 Remedies. If any state tax to which this Section applies is enacted subsequent to the date of this instrument, this shall have the same effect as an Event of Default, and Lender may exercise any or all of the remedies available to it unless the following conditions are met:

(a) Borrower may lawfully pay the tax or charge imposed by state tax; and

(b) Borrower pays the tax or charge within thirty (30) days after notice from Lender that the tax has been levied.

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32. ATTORNEYS’ FEES. In the event suit or action is instituted to enforce or interpret any of the terms of this Instrument (including without limitation efforts to modify or vacate any automatic stay or injunction), the prevailing party shall be entitled to recover all expenses reasonably incurred at, before and after trial and on appeal whether or not taxable as costs, or in any bankruptcy proceeding including, without limitation, attorney’s fees, witness fees (expert and otherwise), deposition costs, copying charges and other expenses. Whether or not any court action is involved, all reasonable expenses, including but not limited to the costs of searching records, obtaining title reports, surveyor reports, title insurance, trustee fees, and other attorney fees, incurred by Lender that are necessary at any time in Lender’s opinion for the protection of its interest or enforcement of its rights shall become a part of the Indebtedness payable on demand and shall bear interest from the date of expenditure until repaid at the interest rate as provided in the Note. The term “attorneys’ fees” as used in the Load Documents shall be deemed to mean such fees as are reasonable and are actually incurred.

33. GOVERNING LAW; SEVERABILITY. This instrument shall be governed by the law of the State of California applicable to contracts made and to be performed therein (excluding choice-of-law principles). In the event that any provision or clause of this Instrument or the Note conflicts with applicable law, such conflict shall not affect other provisions of this Instrument or the Note conflicts with applicable law, such conflict shall not affect other provisions of this Instrument or the Note which can be given effect without the conflicting provision, and to this end of the provisions of this Instrument and the Note are declared to be severable.

34. TIME OF ESSENCE. Time is of the essence of this Instrument.

35. CHANGES IN WRITING. This Instrument and any of its terms may only be changed, waived, discharged or terminated by an Instrument in writing signed by the party against which enforcement of the change, waiver, discharge or termination is sought. Any agreement subsequently made by Borrower or Lender relating to this Instrument shall be superior to the rights of the holder of any intervening lien of encumbrance.

36. NO OFFSET. Borrower’s obligation to make payments and perform all obligations, covenants and warranties under this instrument and under the Note shall be absolute and unconditional and shall not be affected by any circumstance, including without limitation any setoff, counterclaim, abatement, suspension, recoupment, deduction, defense or other right that Borrower or any guarantor may have or claim against Lender or any entity participating in making the loan secured hereby. The foregoing provisions of this section, however, do not constitute a waiver of any claim or demand which Borrower or any guarantor may have in damages or otherwise against lender or any other person, or preclude Borrower from maintaining a separate action thereon; provided, however, that Borrower waives any right it may have at law or in equity to consolidate such separate action with any action or proceeding brought by Lender.

37. WAIVER OF JURY TRAIL. THE BORROWER HEREBY KNOWINGLY, VOLUNTARILY AND INTELLIGENTLY WAIVES ANY AND ALL RIGHTS THAT EACH PARTY TO THIS INSTRUMENT MAY NOW OR HEREAFTER HAVE UNDER THE LAWS OF THE UNITED STATES OF AMERICA OR THE STATE OF CALIFORNIA, TO A TRIAL BY JURY OF ANY AND ALL ISSUES ARISING DIRECTLY OR INDIRECTLY IN ANY ACTION OR PROCEEDING RELATING TO THIS INSTRUMENT, THE LOAD DOCUMENTS OR ANY TRANSACTIONS

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CONTEMPLATED THEREBY OR RELATED THERETO. IT IS INTENDED THAT THIS WAIVER SHALL APPLY TO ANY AND ALL DEFENSES, RIGHTS, CLAIMS AND/OR COUNTERCLAIMS IN ANY SUCH ACTION OR PROCEEDING. BORROWER UNDERSTANDS THAT THIS WAIVER IS A WAIVER OF A CONSTITUTIONAL SAFEGUARD, AND EACH PARTY INDIVIDUALLY BELIEVES THAT THERE ARE SUFFICIENT ALTERNATE PROCEDURAL AND SUBSTANTIVE SAFEGUARDS, INCLUDING A TRIAL BY AN IMPARTIAL JUDGE, THAT ADEQUATELY OFFSET THE WAIVER CONTAINED HEREIN.

38. MAXIMUM INTEREST CHARGES. Notwithstanding anything contained herein or in any of the Loan Documents to the contrary, in no event shall Lender be entitled to receive interest on the loan secured by this Instrument (the “Loan”) in amounts which, when added to all of the other interest charged, paid to or received by Lender on the Loan, causes the rate of interest on the Loan to exceed the highest lawful rate. Borrower and Lender intend to comply with the applicable law governing the highest lawful rate and the maximum amount of interest payable on or in connection with the Loan. If the applicable law is ever judicially interpreted so as to render usurious any amount called for under the Loan Documents, or contracted for, charged, taken, reserved or received with respect to the Loan, or if acceleration of the final maturity date of the Loan or if any prepayment by Borrower results in Borrower having paid or demand having been made on Borrower to pay, any interest in excess of the amount permitted by applicable law, then all excess amounts theretofore collected by Lender shall be credited on the principal balance of the Note (or, if the Note has been or would thereby be paid in full, such excess amounts shall be refunded to Borrower), and the provisions of the Note, this Instrument and any demand on Borrower shall immediately be deemed reformed and the amounts thereafter collectible thereunder and hereunder shall be reduced, without the necessity of the execution of any new document, so as to comply with the applicable law, but so as to permit the recovery of the fullest amount otherwise called for thereunder and hereunder. The right to accelerate the final maturity date of the Loan does not include the right to accelerate any interest which has not otherwise accrued on the date of such acceleration, and Lender does not intend to collect any unearned interest in the event of acceleration. All sums paid or agreed to be paid to Lender for the use, forbearance or detention of the Loan shall, to the extent permitted by applicable law, be amortized, prorated, allocated and spread through the full term of the Loran until payment in full so that the rate or amount of interest on account of the Loan does not exceed the applicable usury ceiling. By execution of this Instrument, Borrower acknowledges that it believes the Loan to be nonusurious and agrees that if, at any time, Borrower should have reason to believe that the Loan is in fact usurious, it will give Lender written notice of its belief and the reasons why Borrower believes the Loan to be usurious, and Borrower aggress that the Lender shall have ninety (90) days following its receipt of such written notice in which to make appropriate refund or other adjustment in order to correct such condition if it in fact exists.

39. REQUEST FOR NOTICE. Pursuant to California Government Code Section 27321.5(b), Borrower hereby requests that a copy of any notice of default and a copy of any notice of sale given pursuant to this Instrument be mailed to Borrower at the address set forth herein above.

40. USE OF DISCRETION. Any provision of this Instrument permitting a party to exercise its discretion shall require such discretion to be exercised reasonably, except for those matters that are specifically reserved for Lender’s sole discretion.

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IMPORTANT: READ BEFORE SIGNING. THE TERMS OF THIS AGREEMENT SHOULD BE READ CAREFULLY BECAUSE ONLY THOSE TERMS IN WRITING ARE ENFORCEABLE. NO OTHER TERMS OR ORAL PROMISES NOT CONTAINED IN THIS WRITTEN CONTRACT MAY BE LEGALLY ENFORCED. YOU MAY CHANGE THE TERMS OF THIS AGREEMENT ONLY BY ANOTHER WRITTEN AGREEMENT.

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IN WITNESS WHEREOF, Borrower has caused this Instrument to be executed by its representative(s) thereunto duly authorized.

BORROWER:
NANOMETRICS INCORPORATED, A Delaware corporation
By:	/s/ Gary Schaefer

Printed Name: Gary Schaefer

Title: Chief Financial Officer

EXHIBITS:

Exhibit A – Description of Property

Schedule 1 – Permitted Exceptions

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STATE OF California	)
	)	SS
COUNTY OF Santa Clara	)

ACKNOWLEDGMENT

On July 24, 2008, before me,                                         , a Notary Public, personally appeared Gary C. Schaefer, who proved to me on the basis of satisfactory evidence to be the person(s) whose name(s) is/are subscribed to the within instrument and acknowledged to me that he/she/they executed the same in his/her/their authorized capacity(ies), and that by his/her/their signature(s) on the instrument the person(s), or the entity upon behalf of which the person(s) acted, executed the instrument.

I certify under PENALTY OF PERJURY under the laws of the State of California that the foregoing paragraph is true and correct.

WITNESS my hand and official seal.

Signature

(Seal)

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Loan No.: 6326048-001

EXHIBIT A

(1550 Buckeye Drive, Milpitas, Santa Clara County, California)

Legal Description:

Real property in the City of Milpitas, County of Santa Clara, State of California, described as follows:

PARCEL ONE:

PARCEL 1, AS SHOWN ON PARCEL MAP FILED NOVEMBER 4, 1998 IN BOOK 709 OF MAPS, AT PAGE(S) 41 AND 42, SANTA CLARA COUNTY RECORDS.

PARCEL TWO:

PERMANENT NON-BUILDING EASEMENT OVER A PORTION OF PARCEL 3, AS SHOWN ON PARCEL MAP ABOVE REFERRED TO.

PARCEL THREE:

TWO 10’ WIDE PRIVATE STORM DRAINAGE EASEMENTS OVER PARCEL 3, AS SHOWN ON PARCEL MAP ABOVE REFERRED TO.

PARCEL FOUR:

RECIPROCAL EMERGENCY ACCESS EASEMENT OVER PARCEL 3, AS SHOWN ON PARCEL MAP ABOVE REFERRED TO.

APN: 086-03-093

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Loan No.: 6326048-001

SCHEDULE 1

(1550 Buckeye Drive, Milpitas, Santa Clara County, California)

Permitted Exceptions:

The land lies within the boundaries of proposed community facilities District No. 2005-1, as disclosed by a map filed April 08, 2005 in Book 41, Page 3 of maps of assessment and community facilities districts recorded April 08, 2005 as Document No. 18310933.

Covenants, conditions, restrictions and easements in the document recorded June 5, 1979 as Book E545, Page 189 of Official Records, which provide that a violation thereof shall not defeat or render invalid the lien of any first mortgage or deed of trust made in good faith and for value, but deleting any covenant, condition or restriction indicating a preference, limitation or discrimination based on race, color, religion, sex, handicap, familial status, national origin, sexual orientation, marital status, ancestry, source of income or disability, to the extent such covenants, conditions or restrictions violate Title 42, Section 3604(c), of the United States Codes or Section 12955 of the California Government Code. Lawful restrictions under state and federal law on the age of occupants in senior housing or housing for older persons shall not be construed as restrictions based on familial status.

Document(s) declaring modifications thereof recorded June 15, 1979 as Book E571, Page 359 of Official Records.

An easement for private storm drainage and incidental purposes, recorded January 29, 1992 as Book M25, Page 1191 of Official Records.

In Favor of:	Confederation Life Insurance Company
Affects:	As described therein

An easement shown or dedicated on the map filed or recorded November 04, 1998 as Book 709, Pages 41 and 42 of Maps

For: Public Service utility and incidental purposes.

(Affects the Westerly 10 feet of said land)

An easement shown or dedicated on the map filed or recorded November 04, 1998 as Book 709, Pages 41 and 42 of Maps

For: Permanent non-building and incidental purposes.

(Affects as shown on said map)

An easement shown or dedicated on the map filed or recorded November 04, 1998 as Book 709, Pages 41 and 42 of Maps

For: Reciprocal emergency access and incidental purposes.

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EX-10.3

Exhibit 10.3

FOR SETTLEMENT PURPOSES ONLY

CONFIDENTIAL SETTLEMENT AGREEMENT

AND

GENERAL RELEASE

This Confidential Settlement Agreement and General Release (“Agreement”) is made and entered into by and among Nanometrics Incorporated (the “Company”), on the one hand; and Gary C. Schaefer (“Executive”), an individual, on the other hand.

R E C I T A L S

A. Executive has been employed by the Company as its Chief Financial Officer since on or about November 7, 2007.

B. The Company and Executive have voluntarily agreed that Executive’s employment as an employee and officer of the Company will be terminated, effective as of the Effective Date (as defined in Section 26 below).

C. Executive, on the one hand, and the Company, on the other hand, desire to resolve all of their disputes and differences, and to determine their respective rights, benefits, duties, and obligations arising out of Executive’s employment by and termination of employment, including all rights and obligations arising out of Executive’s Employment Agreement dated November 5, 2007, (“Employment Agreement”) and therefore enter into this Agreement upon the terms and conditions hereinafter set forth.

NOW, THEREFORE, in consideration of the mutual promises, covenants, representations and agreements herein contained, the parties hereto agree as follows:

A G R E E M E N T

1. Separation. Executive confirms that he resigned effective September 5, 2008 and that his active employment with the Company as an employee and officer ended on the date on which this Agreement was executed by Executive (“Termination Date”) and except as set forth herein, that he will not perform any duties, functions, or services for the Company after this date.

2. Final Payments. Executive acknowledges that on the last day of his employment, he will receive payment for any accrued, but unused, vacation pay and his final paycheck.

3. Payments to Executive. Within ten (10) business days following the Effective Date of this Agreement fully executed by Executive, the Company shall commence make the following payments to Executive:

a) Continued payment of Executive’s Base Salary for six (6) months, paid in accordance with the Company’s normal payroll practices, less the required federal and state withholding for taxes (“Severance Period”).

b) C.O.B.R.A. reimbursement for six (6) months.

c) One third (1/3) of unvested RSU’s and one third (1/3) of unvested stock options shall become vested n the Effective Date of this Agreement. The one-third of the unvested stock options will accelerate beginning with the lowest exercise price.

d) payment of $5,000 to Executive’s attorneys by check made payable to McGuinn, Hillsman & Palefsky which will be reported by the Company on a Form 1099.

4. No Future Employment by Company. Executive shall not knowingly seek or apply for employment by Company or any of its entities at any time.

5. General Release of Company. Except for the obligations set forth herein, Executive hereby acknowledges full and complete satisfaction of and does hereby release and fully discharge Company and its predecessors, successors, parents, subsidiaries, and affiliated entities, past and present, as well as its partners, officers, directors, shareholders, agents, servants, employees, representatives, attorneys, heirs, insurers, successors and assigns, past and present, and each of them (collectively referred to as the “Company Released”), from any and all claims, demands, and causes of action of every kind and nature (including, without limitation, claims for damages, costs, expenses, loss of services, loss of consortium, and attorneys’ and accountants’ fees and expenses), whether asserted or unasserted, known or unknown, or suspected or unsuspected, which Executive now owns or holds or at any time heretofore has owned or held against the Company Released, or any of them, arising out of, resulting from, or in any way related to any transaction, agreement, occurrence, act, or omission whatsoever occurring, existing, or omitted at any time before the date hereof, including, without limiting the generality of the foregoing, those claims, demands, and causes of action,

(a) arising out of or in connection with any transaction, occurrence, act, or omission set forth or facts alleged, or which might have been alleged, in any legal proceeding; or

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(b) arising out of or in way connected at any time with Executive’s employment by Company, his Employment Agreement, or his termination by Company thereof; or

(c) arising out of any actions, comments, communications (written or oral), disclosures, directives, examinations or investigations in connection with or that occurred during Executive’s employment by Company, or

(d) arising out of any federal, state, or other government statute or ordinance including, without limitation, Title VII of the Civil Rights Act of 1964 (42 U.S.C. §§ 2000e-2000e-17), the federal Age Discrimination in Employment Act of 1967 (29 U.S.C. § 21 et seq.), the California Fair Employment and Housing Act, or any other legal limitation on the employment relationship.

This waiver and release shall not waive or release claims where the events in dispute first arise after execution of this Agreement, claims which cannot be released as a matter of law or public policy, nor shall it preclude Executive or the Company from filing a lawsuit for the exclusive purpose of enforcing their respective rights under this Agreement.

6. Release of Executive. Except for the obligations set forth herein, the Company hereby acknowledges full and complete satisfaction of and does hereby release and fully discharge Executive from any and all claims, demands, and causes of action of every kind and nature (including, without limitation, claims for damages, costs, expenses, and attorneys’ and accountants’ fees and expenses), including without limitation any claim (except for the confidentiality provisions) that the Company has had or may hereafter have under Executive’s original offer of employment letter, whether known or unknown, suspected or unsuspected, which the Company now owns or holds or at any time heretofore has owned or held against Executive arising out of, resulting from, or in any way related to any transaction, agreement, occurrence, act, or omission whatsoever occurring, existing, or omitted at any time before the date hereof.

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7. Release of Unknown Claims. It is the intention of the parties hereto in executing this Agreement that this instrument is a General Release which shall be effective as a bar to each and every claim, demand, or cause of action released hereby. Each Party recognizes that it may have some claim, demand, or cause of action against the other party of which it is totally unaware and unsuspecting, which it is giving up by execution of this Agreement. It is the intention of the parties in executing this Agreement that it will deprive them of each such claim, demand or cause of action and prevent them from asserting it against any other party to whom a General Release herein has been given. In furtherance of this intention, each party hereto expressly waives any rights or benefits conferred by the provisions of Section 1542 of the Civil Code of the State of California, which provides as follows:

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

8. Consultation with Counsel. Each party hereto acknowledges and represents that said party has consulted with legal counsel before effecting this settlement and release and in executing this Agreement and understands its meaning, including the effect of Section 1542 of the California Civil Code, and expressly consents that this Agreement shall be given full force and effect according to each and all of its express terms and provisions, including those relating to the release of unasserted, unknown and unsuspected claims, demands, and causes of action.

9. No Admissions. This Agreement is part of the compromise and settlement of contested claims. No action taken by the parties hereto, either previously or in connection with the compromise reflected in this Agreement, shall be deemed or construed to be an admission of the truth or falsity of any matter pertaining to any claim, demand, or cause of action referred to herein or relating to the subject matter of this Agreement, or any acknowledgment by them, or any of them, of any fault or liability to any party hereto or to any other person in connection with any matter or thing.

10. No Assignments. Each party hereto represents and warrants to each other party hereto that no portion of any claim, demand, cause of action, or other matter released herein, nor any portion of any recovery or settlement to which one party might be entitled from another party, has been assigned or transferred to any other person or entity, either directly or by way of subrogation or operation of law. Each party hereby agrees to indemnify, defend, and hold harmless each other party, and each of them, from all loss, cost, claim, or expense (including, but not limited to all expenses of investigation and defense of any such claim or action, including reasonable attorneys’ and accountants’ fees and expenses) arising out of any claim made or action instituted by any person or entity who claims to be the beneficiary of such assignment or transfer, and to pay and satisfy any judgment resulting from or any settlement of any such claim or action.

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11. Governing Law. This Agreement and its terms and conditions shall be governed by the laws and construed solely in accordance with the laws of the State of California.

12. Failure or Delay Not A Waiver. No failure or delay on the part of any party to exercise any right hereunder, nor any other indulgence of such party, shall operate as a waiver of any other rights hereunder, nor shall any single exercise by any party of any right hereunder preclude any other or further exercise thereof. The rights and remedies herein provided are cumulative and not exclusive of any rights or remedies provided by law.

13. No Representations. Each party hereto acknowledges that he or it has relied wholly upon his or its own judgment, belief and knowledge of the existence, nature and extent of each claim, demand, or cause of action that he or it may have against another which is hereby released and that he or it has not been influenced to any extent in entering into this Agreement by any representations or statements regarding any such claim, demand, or cause of action made by any other party hereto. Each party acknowledges that he or it is executing and delivering this Agreement after having received from legal counsel of his or its own choosing legal advice as to his or its rights hereunder and the legal effect hereof.

14. Attorneys’ Fees and Costs. Each party hereto shall bear his or its costs incurred in connection with the preparation of this Agreement. In the event any litigation, arbitration or other proceeding is brought for the interpretation or enforcement of this Agreement, or because of an alleged dispute, default, misrepresentation, or breach in connection with any of the provisions of this Agreement, the successful or prevailing party(ies) shall be entitled to recover reasonable attorneys’ fees, costs, and expenses actually incurred in connection therewith, in addition to any other relief to which he or it may be entitled.

15. Integration. This Agreement constitutes the entire understanding between and among the parties hereto pertaining to the subject matter hereof and fully supersedes any and all prior agreements and understandings, whether written or oral, between the parties hereto pertaining to the subject matter hereof.

16. Amendments. No changes in, additions to, or modifications of this Agreement shall be valid unless set forth in writing executed by all parties hereto.

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17. Successors and Assigns. The provisions of this Agreement shall be binding upon and inure to the benefit of the respective parties and their heirs, executors, administrators, agents, representatives, successors, and assigns.

18. Additional Documents. The parties hereto agree to execute such additional documents and perform such further acts as may be reasonably necessary to effectuate the purpose of this Agreement.

19. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.

20. Headings and Pronouns. The Headings in this Agreement are for convenience or reference only, and shall not limit or otherwise affect the meaning hereof. Reference to “he” or “his” shall include reference to she, it and they, and hers, its and theirs, respectively.

21. Authority to Execute. Each individual signing this Agreement, and any other documents executed in connection with this Agreement, whether signed individually or on behalf of any person or entity, warrants and represents that he or she has full authority to so execute the Agreement on behalf of the parties on whose behalf he or she so signs. Each separately acknowledges and represents that this representation and warranty is an essential and material provision of this Agreement and shall survive execution of this Agreement.

22. Agreement Binding, Enforceable, and Admissible. This Agreement is binding, enforceable, and is admissible in any proceeding to enforce its terms.

23. Confidentiality and Non-Disclosure.

(a) Each party to this Agreement promises that they will maintain this Agreement’s existence and terms in strict confidence and shall not disclose the same, directly or indirectly, to any person, union, or entity of whatever nature except to (1) any legal counsel it may retain to advise them regarding this Agreement, so long as such counsel agrees to keep its terms confidential; (2) their accountants or financial advisors (if any), so long as such individuals agree to keep its terms confidential; or (3) as otherwise required by law.

(b) By this Agreement, each party to this Agreement expressly represents and warrants that they have not communicated, and will not communicate, the existence and/or terms of this Agreement to anyone other than the parties identified in Section 23(a) and will do everything possible (including, without limitation, directing such individuals to hold any information disclosed in strict confidence) to further ensure that such information remains confidential.

6

(c) The parties agree that if either party to this Agreement is asked about any dispute concerning Executive’s employment at or termination by Company, the only response from any party shall be, “Gary made substantial contributions to Company and we wish him well in future endeavors” or a similar response to that effect.

24. No Disparagement. The parties to this Agreement agree that neither the Company, nor any of its officers or directors, will disparage Executive, and that Executive shall not disparage the Company or its officers or directors, agents or other employees, in each case refraining from any statement that is in any manner materially harmful to Executive’s personal reputation or the Company’s business reputation, respectively.

25. Payment of Taxes and Indemnity. The Company makes no representations with regard to the effect on Executive’s foreign, federal, state and/or local income tax liability in regard to the foregoing consideration paid to Executive, and Executive hereby assumes full and sole responsibility for payment of taxes due, if any, on the consideration tendered herein and further agrees to defend, indemnify, and hold the Company harmless from and against any loss, liability, obligation, action, cause of action, claims, demands or other expenses of any nature whatsoever, relating to, in connection with or arising out of the payment of said taxes and interest, and/or penalties imposed, arising out of any such tax.

26. Acknowledgement of Waiver of Claims under ADEA. Executive acknowledges that he is waiving and releasing any rights he may have under the Age Discrimination in Employment Act of 1967 (“ADEA”) and that this waiver and release is knowing and voluntary. Executive agrees that this waiver and release does not apply to any rights or claims that may arise under the ADEA after the Effective Date of this Agreement. Executive acknowledges that the consideration given for this waiver and release is in addition to anything of value to which Executive was already entitled. Executive further acknowledges that he has been advised by this writing that: (a) he should consult with an attorney prior to executing this Agreement; (b) he has twenty-one (21) days within which to consider this Agreement; (c) he has seven (7) days following his execution of this Agreement to revoke the Agreement by doing so in writing addressed to Tim Stultz at the Company’s offices at 1550 Buckeye Drive, Milpitas, CA 95035; and (d) this Agreement shall not be effective until the seven-day revocation period has expired (“Effective Date”).

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IN WITNESS WHEREOF, the parties hereto have executed this Agreement, consisting of 10 pages, including this page.

DATED: September 5, 2008	Nanometrics Incorporated
	By:	/s/ Timothy Shultz
		CEO “Company”
DATED: September 5, 2008
		/s/ Gary C. Schaefer
		Gary C. Schaefer
		“Executive”

APPROVED AS TO FORM:
PERKINS COIE LLP
By:	/s/ William H. Emer
	William H. Emer
APPROVED AS TO FORM:
MCGUINN, HILLSMAN & PALEFSKY
By:	/s/ Cliff Palesky
	Cliff Palesky

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EX-31.1

Exhibit 31.1

I, Timothy J. Stultz, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Nanometrics Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 6, 2008

By:	/s/ Timothy J. Stultz
	Timothy J. Stultz
	Chief Executive Officer

EX-31.2

Exhibit 31.2

I, Bruce A. Crawford, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Nanometrics Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 6, 2008

By:	/s/ Bruce A. Crawford
	Bruce A. Crawford
	Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Timothy J. Stultz, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Nanometrics Incorporated on Form 10-Q for the quarterly period ended September 27, 2008 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of Nanometrics Incorporated.

November 6, 2008	/s/ Timothy J. Stultz
	Timothy Stultz
	Chief Executive Officer

I, Bruce A. Crawford, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Nanometrics Incorporated on Form 10-Q for the quarterly period ended September 27, 2008 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of Nanometrics Incorporated.

November 6, 2008	/s/ Bruce A. Crawford
	Bruce A. Crawford
	Chief Financial Officer