Emphysema is a chronic lung disease characterized by alveolar enlargement and tissue loss. Tissue engineering represents an attractive potential for regeneration of several organ systems. The complex three-dimensional architectural structure of lung parenchyma requiring connections of alveolar units to airways and the pulmonary circulation makes this strategy less optimistic. In the present study, we used Gelfoam® sponge, as a scaffold material, supplemented with fetal rat lung cells as progenitors, to explore the potential application of cell-based tissue engineering for lung regeneration in adult rats. After injection into lung parenchyma the sponge showed similar porous structures as alveolar units. It did not induce severe local inflammatory response. Fetal lung cells in the sponge were able to survive in the adult lung for at least 35 days, determined by CMTMR labeling. Proliferation of cells within sponge was demonstrated in vivo by BrdU labeling. Cells formed "alveolar like structures" at the border between the sponge and the surrounding lung tissue with positive immunohistochemical staining for epithelial and endothelial cells. Neovascularization of the sponge was demonstrated with India ink perfusion. The sponge degraded after several months. This study suggests that cell-based tissue engineering possesses the potential to regenerate alveolar like structures, an important step towards our ultimate goal of lung regeneration.