A key goal of cellular engineering is to manipulate progenitor cells to become beta-cells, allowing cell replacement therapy to cure diabetes mellitus. As a paradigm for cell engineering, we have studied the molecular mechanisms by which AR42J cells become beta-cells. Bone morphogenetic proteins (BMPs), implicated in a myriad of developmental pathways, have not been well studied in insulin-positive differentiation. We found that the canonical intracellular mediators of BMP signaling, Smad-1 and Smad-8, were significantly elevated in AR42J cells undergoing insulin-positive differentiation in response to exendin-4 treatment, suggesting a role for BMP signaling in beta-cell formation. Similarly, endogenous BMP-2 ligand and ALK-1 receptor (activin receptor-like kinase-1; known to activate Smads 1 and 8) mRNAs were specifically up-regulated in exendin-4-treated AR42J cells. Surprisingly, Smad-1 and Smad-8 levels were suppressed by the addition of BMP-soluble receptor inhibition of BMP ligand binding to its receptor. Here, insulin-positive differentiation was also ablated. BMP-2 ligand antisense also strongly inhibited Smad-1 and Smad-8 expression, again with the abolition of insulin-positive differentiation. These results demonstrate a previously unrecognized key role for BMP signaling in mediating insulin-positive differentiation through the intracellular Smad signaling pathway. In short, BMP signaling may represent a novel downstream target of exendin-4 (glucagon-like peptide 1) signaling and potentially serve as an upstream regulator of transforming growth factor-beta isoform signaling to differentiate the acinar-like AR42J cells into insulin-secreting cells.