Activation of the innate immune response in Metazoans is initiated through the recognition of microbes by host pattern-recognition receptors. In Drosophila, diaminopimelic acid (DAP)-containing peptidoglycan from Gram-negative bacteria is detected by the transmembrane receptor PGRP-LC and by the intracellular receptor PGRP-LE. Here, we show that PGRP-SD acted upstream of PGRP-LC as an extracellular receptor to enhance peptidoglycan-mediated activation of Imd signaling. Consistent with this, PGRP-SD mutants exhibited impaired activation of the Imd pathway and increased susceptibility to DAP-type bacteria. PGRP-SD enhanced the localization of peptidoglycans to the cell surface and hence promoted signaling. Moreover, PGRP-SD antagonized the action of PGRP-LB, an extracellular negative regulator, to fine-tune the intensity of the immune response. These data reveal that Drosophila PGRP-SD functions as an extracellular receptor similar to mammalian CD14 and demonstrate that, comparable to lipopolysaccharide sensing in mammals, Drosophila relies on both intra- and extracellular receptors for the detection of bacteria.