S. cerevisiae kex2 mutants are defective for the production of two biologically active secreted peptides: killer toxin and the mating pheromone, alpha-factor. Both molecules are excised from larger precursor polypeptides. In normal cells, the alpha-factor precursor is core-glycosylated and proteolytically processed intracellularly. In kex2 mutants, however, prepro-alpha-factor is not proteolytically cleaved and is secreted in a highly glycosylated form. All kex2 mutants examined (three independent alleles) lack a Zn++-sensitive membrane-associated endopeptidase with specificity for cleaving on the carboxyl side of a pair of basic residues. Absence of this activity cosegregates with the other phenotypes of a kex2 lesion in genetic crosses. The normal KEX2 gene was isolated by complementation of three of the phenotypes conferred by the kex2-1 mutation. The cloned DNA, either on a multicopy plasmid or integrated into the genome, restores both enzymatic activity in vitro and the normal pattern of proteolytic processing and glycosylation of prepro-alpha-factor in vivo. Gene dosage effects suggest that KEX2 is the structural gene for the endopeptidase.