Previous studies in Drosophila have shown that heparan sulfate proteoglycans (HSPGs) are involved in both breathless (btl)- and heartless (htl)-mediated FGF signaling during embryogenesis. However, the mechanism(s) by which HSPGs control Btl and Htl signaling is unknown. Here we show that dally-like (dlp, a Drosophila glypican) mutant embryos exhibit severe defects in tracheal morphogenesis and show a reduction in btl-mediated FGF signaling activity. However, htl-dependent mesodermal cell migration is not affected in dlp mutant embryos. Furthermore, expression of Dlp, but not other Drosophila HSPGs, can restore effectively the tracheal morphogenesis in dlp embryos. Rescue experiments in dlp embryos demonstrate that Dlp functions only in Bnl/FGF receiving cells in a cell-autonomous manner, but is not essential for Bnl/FGF expression cells. To further dissect the mechanism(s) of Dlp in Btl signaling, we analyzed the role of Dlp in Btl-mediated air sac tracheoblast formation in wing discs. Mosaic analysis experiments show that removal of HSPG activity in FGF-producing or other surrounding cells does not affect tracheoblasts migration, while HSPG mutant tracheoblast cells fail to receive FGF signaling. Together, our results argue strongly that HSPGs regulate Btl signaling exclusively in FGF-receiving cells as co-receptors, but are not essential for the secretion and distribution of the FGF ligand. This mechanism is distinct from HSPG functions in morphogen distribution, and is likely a general paradigm for HSPG functions in FGF signaling in Drosophila.