As I mentioned on the SP1 cheat sheet, client profile is an exciting new deployment feature in SP1..  
Troy Martez has an intro paper and a deployment guide for it. 
Those docs and his coming blog are the ultimate reference on client profile, but I wanted to share the whole context and my 2c on the subject [because I have seen a lot of questions on the feature]. 
[For most of you readers half of this is old news, feel free to skip to the highlighted sentences].

The motivation for client profile:

The .NET run-time has gotten big over time.  The growth was positive- we got WPF, WCF, Card Space, LINQ, etc- but the trade-off was increased download size and increased install time .
The bad rep on download size is compounded by how we package the off-line installers.  For example, the off-line 3.5 SP1 installer,  is ~230 MB. The reason for it is because we ship x86, x64, and ia64 bundled together. The reality is that if you used the 3.5 SP1 boot-strapper and installed online, you would get 1/3 of that size, with a ~3 MB bootstrapper (instead of the whoopy 200mb).   

Introducing client profile

The idea is simple:
1) package the subset of the framework that is most commonly used by client apps.
2) install that subset.
3) later (on the background preferably), upgrade the subset installed to a full .NET 3.5 SP1. 
This package in #1 above is the client profile SKU.  Client profile includes WPF, Windows Forms, WCF, the BCL, data access, etc.  (for a full manifest, check Justin's post).
The net result is that client profile gives you a .NET run-time with an initial download of ~28 MB and install time much shorter than full .NET framework. 

The details on the implementation
If you read #1 above, client profile is a subset of the framework. The more accurate explanation is that it is a subset of .NET 1.1x + subset of 2.0 + subset of 3.x so unfortunately we can not install client profile on a machine that already has a .NET framework installed.  

  • Why only install on 'clean' machines?  If you have the full 2.0 framework, and we installed a subset of that, it that could break your 2.0 apps already installed.
  • If you think further into this, Vista shipped with the .NET framework 3.0 in the box, so that gets Vista out of the way and we conclude that client profile is supported on XP machines that do not have a framework installed at all.  For WS03, since it is server, we don't do client profile.
  • On any machine that is not XP or that already has a framework, when you try to install client profile, it will install the full .NET 3.5 SP1.  

If you see above again, step #3 is upgrading the framework from client profile to full .NET 3.5 SP1.. how does it happen?

  • Once you install client profile, the next time Windows Update runs on that system, it will try to upgrade it to full .NET 3.5 SP1. This is nice because the download and install happens on the background (for me windows update runs at 3 am every day).
  • There is likely a brief period of time when a machine between client profile getting installed and Windows Update upgrading it to a full 3.5 SP1. What happens during this period?
    • Any apps coded against 3.5 SP1 client profile will run fine.
    • Any apps that need the full framework, will prompt for a full framework install when they are launched.  You will be able to install full-framework seamlessly you just won't get the benefit of this happening on the background (if you used Windows Update).

The temporary gotcha
.NET 3.5 SP1 shipped last week, and client profile is available for download but Windows Update does not start updating machines to .NET 3.5 SP1 until they complete their testing - 4 to 6 weeks from now, we hope-.   So if you installed client profile today you would not be upgraded automatically like we planned. Because of this reason, we are labeling the Client Profile release as "Preview" until Windows update begins upgrading systems to 3.5 SP1.

This does not mean the run-time with change; the run-time is frozen. We have the preview out for people to start testing their app against client profile and planning the deployment;  we just recommend that you wait and release a client profile app only after Windows Update begins upgrading systems to 3.5 SP1.

Other FAQs:
A point of confusion is the packaging.  Client profile is ~28 MB, but if you go to download it, you will see two options available: 

  • The bootstrapper for client profile is a tiny exe ( < 300K). It should be used for applications that will be online when you install. The bootstrapper looks at your OS and hardware platform ( e.g. x86) and only downloads the needed bits (~28 MB). This is online scenario is what client profile is designed for.
  • The client profile off-line installer. Most people would think this is a 28 MB file, would not you? 
    Well, unfortunately not. It is actually ~250MB. The reason for that is we assume you will be off-line and your application can't fail at install time, so we include the whole 3.5 SP1 package plus the 28 MB client profile, this way if you try to install it on a machine that already has the framework, we can still install 3.5 and have your application will run. 
    • My personal 2c here is that most people who need to install off-line would be better off installing the full 3.5 SP1 framework at once. It is slightly smaller package and most importantly gets it all out of the way, so there is no WU upgrade later; the only gotcha is that the installer will take a bit longer to install than using client profile.

I am sure there are a lot more questions you will have (like how do I create an app that targets client profile). 
I will come back to client profile later, or at least point you to Troy's blog since he is working on explaining all of these.   For today, I just wanted to explain the platforms and scenarios that client profile aims to address, its relationship to Windows Update, and the explanation on the off-line installer's size (this was causing confusion, at least for me).  For the record a benefit I did not tout today is that client profile lets you customize the UI for the install experience; I will have to come back to that one since it is neat-o.