Surfactant protein C (SP-C) is synthesized by type II pneumocytes as a 21-kD propeptide (proSP-C) which is proteolytically processed to a 4.2-kD dipalmitoylated protein. To characterize the processing of proSP-C and the role of the cysteine protease cathepsin H, we studied the localization of proSP-C and cathepsin H in human as well as proSP-C in rat lungs, the enzymatic cathepsin H activity in isolated rat lamellar bodies, and the cleavage of human proSP-C by purified cathepsin H. Using antisera directed against the N-terminal E(11)-R(23) (NPROSP-C(11-23)), the C-terminal G(162)-G(174) domain (CPROSP-C(162-174)) of proSP-C, and against cathepsin H, immunogold labeling identified all three in electron-dense multivesicular bodies, but only NPROSP-C(11-23) and cathepsin H in composite as well as lamellar bodies of type II pneumocytes. Immuno double-labeling further distinguished electron-dense vesicles containing cathepsin H or electron light vesicles/multivesicular bodies containing proSP-C. Isolated lamellar bodies contained enzymatically active cathepsin H, a 6-kD proSP-C processing intermediate detected only by NPROSP-C(11-23), and mature SP-C. Using enzyme activities comparable to those in isolated lamellar bodies, purified cathepsin H generated a partially N-terminal processed proSP-C intermediate in vitro. In conclusion, our results indicate that after the fusion of electron-dense vesicles containing cathepsin H and electron-light vesicles or multivesicular bodies containing proSP-C, cathepsin H is involved in the first N-terminal processing step of proSP-C in electron-dense multivesicular bodies of type II pneumocytes.