Pseudomonas exotoxin (PE) is a 66-kDa bacterial toxin that is proteolytically cleaved by cells to produce an N-terminal fragment of 28 kDa and a C-terminal 37-kDa fragment which translocates to the cytosol and inhibits protein synthesis (M. Ogata, V.K. Chaudhary, I. Pastan, and D.J. FitzGerald, J. Biol. Chem. 265:20678-20685, 1990). When cells were broken by homogenization, the appropriate proteolytic activity was found associated with cellular membranes and not in a soluble fraction. Proteolysis of PE by crude membranes was stimulated by divalent cations, was ATP independent, and had a pH optimum of 5.5. When cells were disrupted by nitrogen cavitation and fractionated on Percoll gradients, proteolytic activity was present in fractions corresponding to the density of plasma membranes or endosomes but not in fractions containing lysosomes. Proteolytic activity was recovered in detergent extracts after crude membranes were treated with Nonidet P-40 or octylglucoside. Proteolysis of PE by either crude membranes or detergent extracts generated fragments of 28 and 37 kDa. The sizes of these fragments resembled those produced by intact cells. However, when the nontoxic mutant, PEgly276, which cannot be cleaved appropriately by intact cells, was incubated with membranes or extracts there was no production of the 28- and 37-kDa fragments.