The "Pro Applications Update 2008-02" is the problem.
This download updates Final Cut Pro to 6.0.4 and Compressor to 3.0.3 in a single combined update.
Compressor 3.0.3 unfortunately breaks the automatic Proxy generation functions of Final Cut server regardless of whether you have FCSvr 1.0 or 1.1 installed.
You will have to uninstall Compressor and then if you like update to no further than Compressor version 3.0.2. Even Compressor 3.0 will function normally with FCSvr 1.0 or 1.1.
Make sure to send your comments to the Apple Pro Apps Feedback:
http://www.apple.com/feedback/finalcutserver.html