.NET 3.5 SP1 has only just been released any I've already seen three distinct reports that it's introduced bugs that break applications. See here and here for examples, and at least one vendor who's update list I'm on has sent a warning email to notify people .NET 3.5 SP1 breaks their product.
Fortunately I've only installed it on my home system which I don't use for anything but personal development. Given the nature of .NET 3.5 (such as the shared runtime with .NET 2.0/3.0) this has the potential to break applications running on earlier .NET versions. Solid testing before rolling it out looks essential.