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This should go without saying, but make sure you back up EVERYTHING before formatting. Formatting, by definition, erases everything on the HD.
About SP2. I've installed it on 6 computers and have had only one problem. It didn't get along with Norton SystemWorks2003. I uninstalled Norton SW2003 and everything was happy. SP2 probably has fewer flaws than any Windows update released. All the flaws that do exist are documented by Microsoft and most of them were semi-planned problems. I say this because many of the programs that SP2 "breaks" are older programs which use antiquated features in XP. Microsoft removed some of the antiquated features for security reasons, thus causing the programs to no longer work. Also, I'm not a Microsoft fan at all. If my classes didn't require me to run Windows (for things like programming in VB), I would be running Linux on all my computers. I hate Microsoft, but they've actually done OK with SP2.
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