Periosteum has cell populations, including osteoprogenitor and chondroprogenitor cells, that can be grown in cell culture and form both bone and cartilage under appropriate conditions. The authors have shown previously that cultured periosteal cells can be used in the tissue engineering of bone, and they demonstrated substantial bone formation in a rabbit cranial defect model. In the current study, principles of tissue engineering were combined with principles of gene therapy to produce cultured periosteal cells transduced retrovirally with the bone morphogenetic protein 7 (BMP-7) gene to be used in the treatment of bone defects. Human BMP-7 complementary deoxyribonucleic acid was generated from a cell line using reverse transcription polymerase chain reaction and cloned into a retroviral vector plasmid. Retroviral vector particles were then used to transduce New Zealand White rabbit periosteal cells. Transduced periosteal cells demonstrated substantial production of both BMP-7 messenger ribonucleic acid by Northern blot analysis and BMP-7 protein by enzyme-linked immunosorbent assay. These cells were then seeded into polyglycolic acid (PGA) matrices and used to repair critical-size rabbit cranial defects. At 12 weeks, defect sites repaired with BMP-7-transduced periosteal cells/PGA had significantly increased radiographic and histological evidence of bone repair compared with those defect sites repaired with negative control-transduced cells/PGA, nontransduced cells/PGA, PGA alone, or unrepaired defects. Thus, this study demonstrates successfully a tissue engineering approach to bone repair using genetically modified cells.