Previous studies have demonstrated that Disp1 function is essential for Shh and Ihh signaling in the mouse, and Disp1 gene dose regulates the level of Shh signaling activity in vivo. To determine whether Disp1 activity is required in Shh-producing cells for paracrine signaling in Shh target fields, we used a ShhGFP-Cre (here shortened to ShhCre) knock-in allele and a Disp1 conditional allele to knock down Disp1 activity specifically within Shh-producing cells. The resulting facial and neural tube phenotypes support the conclusion that the primary and probably exclusive role for Disp1 is within hedgehog protein-producing cells. Furthermore, using an allele that produces N-Shh (a noncholesterol modified form of the Shh protein), we demonstrate that N-Shh is sufficient to rescue most of the early embryonic lethal defects in a Disp1-null mutant background. Thus, Disp1 activity is only required for paracrine hedgehog protein signaling by the cholesterol modified form of Shh (N-Shhp), the normal product generated by auto-processing of a Shh precursor protein. In both respects, Disp function is conserved from Drosophila to mice.