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We investigated the role of keratinocyte growth factor (KGF) in regulation of alveolar epithelial cell (AEC) phenotype in vitro. Effects of KGF on cell morphology, expression of surfactant apoproteins A, B, and C (SP-A, -B, and -C), and expression of aquaporin 5 (AQP5), a water channel present in situ on the apical surface of alveolar type I (AT1) cells but not expressed in alveolar type II (AT2) cells, were evaluated in AECs grown in primary culture. Observations were made on AEC monolayers grown in serum-free medium without KGF (control) or grown continuously in the presence of KGF (10 ng/ml) from either Day 0 (i.e., the time of plating) or Day 4 or 6 through Day 8 in culture. AECs monolayers express AQP5 only on their apical surfaces as determined by cell surface biotinylation studies. Control AECs grown in the absence of KGF through Day 8 express increasing levels of AQP5, consistent with transition toward the AT1 cell phenotype. Exposure of AECs to KGF from Day 0 results in decreased AQP5 expression, retention of a cuboidal morphology, and greater numbers of lamellar bodies relative to control on Day 8 in culture. AECs treated with KGF from Day 4 or 6 exhibit a decrease in AQP5 expression through subsequent days in culture, as well as an increase in expression of surfactant apoproteins. These data, showing that KGF both prevents and reverses the increase in AQP5 (and decrease in surfactant apoprotein) expression that accompanies progression of the AT2 toward the AT1 cell phenotype, support the concepts that transdifferentiation between AT2 and AT1 cell phenotypes is at least partially reversible and that KGF may play a major role in modulating AEC phenotype.