The Drosophila segment polarity gene fused encodes a putative protein-serine/threonine kinase, and plays a critical role in the signal transduction for Hedgehog (Hh)-dependent gene expression. We show that the Drosophila Schneider 2 (S2) cell line has the potential to transduce the Hh-triggered intracellular signals, leading to the activation of target gene expression, when a transcription factor, Cubitus interruptus (Ci), is provided exogenously. Using S2 cells transfected with the Ci-expressing plasmid and a patched promoter reporter construct, we demonstrate that the forced expression of Fused (Fu) stimulates Hh-triggered and Ci-dependent transcriptional activation. The N-terminal kinase domain of Fu is required for this activity, but the C-terminal domain is not. Two kinase-inactive Fu mutants fail to enhance the reporter activation, indicating that the kinase catalytic activity is essential for this function. Negative components of the Hh-signaling pathway, Costal-2 and Suppressor of Fused, strongly antagonize the Fu activity, irrespective of the presence or absence of the Fu C-terminal domain, suggesting an indirect mechanism for the inhibition of Fu by these proteins. Furthermore, mutational analyses of threonine 158 and serine 159, in the activation segment of the Fu protein kinase, indicate that threonine 158 is essential for Fu activity and that phosphorylation of this threonine residue may be involved in the activation of the kinase catalytic activity upon Hh stimulation.