Cubitus interruptus (Ci), a Drosophila transcription factor, mediates Hedgehog (Hh) signaling during the patterning of embryonic epidermis and larval imaginal discs. In the absence of Hh signal, Ci is cleaved to generate a truncated nuclear form capable of transcriptional repression. Hh signaling stabilizes and activates the full-length Ci protein leading to strong activation of downstream target genes including patched and decapentaplegic. A number of molecules have been implicated in the regulation of Ci. Mutations in these molecules lead to changes in Ci protein level, the extent of Ci proteolysis and the expression of Ci target genes. This paper examines the regulation of Ci subcellular localization and activity. We first characterize a bipartite nuclear localization signal (NLS) within Ci. We propose that the subcellular distribution of Ci is affected by two opposing forces, the action of the NLS and that of at least two regions targeting Ci to the cytoplasm. Further our data show that loss of PKA or Costal-2 activity does not fully mimic Hh signaling, demonstrating that Ci proteolysis and Ci activation are two distinct events which are regulated through different paths. Finally, we propose that there are three levels of apparent Ci activity, corresponding to three zones along the AP axis with different sets of gene expression and different levels of Hh signaling.