Okay, so you're running the installer that is updating your XPE development environment, right? Or are you attempting to run that on a device before you seal it?
You need to run that installer on the workstation that has the XPE dev environment (and database) installed. The installer is looking for a specific database on a specific instance of Sql Server, so if you have (or somebody else has) changed it, you'll need to read up on how to specify the connection string to use with the installer.
In addition, it's probably trying to connect using your windows account credentials. Make sure you are able to log on to Sql Server, open the DB with the component definitions, and add records to it. Alternatively, if you can specify the connection string you can set a Sql login username and password to use.
Profiler is a great tool for troubleshooting the two issues described above.
Once you have the components installed, you'll have to add them to your image, check your dependencies and then build it.
If you're trying to just install .NET 2.0 on a machine directly (before you reseal it), you will need the packages for Windows Installer on the machine first. There might be some other dependencies; I haven't done it in a long time so I can't remember.
The best way to troubleshoot dependencies on an XPE installation is to put ProcessMonitor from Sysinternals on it. As you run the installer, you'll see where it attempts to find stuff and fails. Take that information back to your XPE IDE and search your components for those files. You then have to add the packages containing those files to your image and try again. Its an arduous process sometimes..,.
It does look like the title is in error, because it says RTM further down on that page.
HOWEVER, a new version of 3.5 SP1 (known as 3.5 SP1 GDR) is about to be released any day now, to fix regressions which were in SP1. You might want to wait for that before a big deployment.
Best Answer
What you're trying to achieve is actually pretty difficult because Windows CE doesn't support transparent windows. You can use Colorkey transparency to draw an image with transparency onto a window, but if that window overlaps yet another window (as is the case in a UserControl on top of a Form) then you'll get either a grey background, or a "hole" all the way to the desktop, depending on whether you've overriden OnPaintBackground in the UserControl.
What you have to do to get it to work is the UserControl has to actually call up to its parent and call it's OnPaint method with the bounds of your clipping region before your draw the UserControl itself.
Unfortunately I don't have a simple code example for this because where we use it we have it pretty tightly coupled to the project UI framework via a base and interface implemented in a IoC Workspace. It would take me a couple hours just to distill it to a simple example (which I intend to do for a blog entry some day, but not today).