Hedgehog (Hh) transduces signal by regulating the subcellular localization and conformational state of the GPCR-like protein Smoothened (Smo) but how Smo relays the signal to cytoplasmic signaling components remains poorly understood. Here, we show that Hh-induced Smo conformational change recruits Costal2 (Cos2)/Fused (Fu) and promotes Fu kinase domain dimerization. We find that induced dimerization through the Fu kinase domain activates Fu by inducing multi-site phosphorylation of its activation loop (AL) and phospho-mimetic mutations of AL activate the Hh pathway. Interestingly, we observe that graded Hh signals progressively increase Fu kinase domain dimerization and AL phosphorylation, suggesting that Hh activates Fu in a dose-dependent manner. Moreover, we find that activated Fu regulates Cubitus interruptus (Ci) by both promoting its transcriptional activator activity and inhibiting its proteolysis into a repressor form. We provide evidence that activated Fu exerts these regulations by interfering with the formation of Ci-Sufu and Ci-Cos2-kinase complexes that normally inhibit Ci activity and promote its processing. Taken together, our results suggest that Hh-induced Smo conformational change facilitates the assembly of active Smo-Cos2-Fu signaling complexes that promote Fu kinase domain dimerization, phosphorylation and activation, and that Fu regulates both the activator and repressor forms of Ci.