During peripheral nervous system (PNS) myelination, Schwann cells must interpret extracellular cues to sense their environment and regulate their intrinsic developmental program accordingly. The pathways and mechanisms involved in this process are only partially understood. We use tissue-specific conditional gene targeting to show that members of the Rho GTPases, cdc42 and rac1, have different and essential roles in axon sorting by Schwann cells. Our results indicate that although cdc42 is required for normal Schwann cell proliferation, rac1 regulates Schwann cell process extension and stabilization, allowing efficient radial sorting of axon bundles.