What is slipstreaming?
Slipstreaming is the technique for combining an installation CD like Windows 2000/ Windows XP, with the latest Service Pack. This drastically cuts down on the time it takes to install a PC, because the patches and OS are installed together. It helps the systems administrators to cut down on the new fresh installation timings without compromising to the security and critical updates. As a network administrator, at times it is very frustrating to install the new fresh operating system and then apply all the latest security patches appropriately. Although Microsoft provides automatic updates either directly from windows updates or using the local software update service, we still have to wait till it becomes available to the required client. Fortunately there is way to overcome this problem by installing new operating system plus the latest service pack at once.
With XP Service Pack 2 just released, users and IT departments across the world are ready to test and update their Microsoft-based PCs with its new features. Updating to service pack 2 (SP2) is a time consuming process, especially if you have more than one PC to upgrade. As usual, Microsoft has published the service pack in the form of a single downloadable file for IT professionals who need to apply it to multiple machines over a network. This is all well and good, but what if you are dealing with dozens of new systems which require XP to be installed, along with its latest service pack?
The idea of installing Windows XP first then applying its latest service pack to each machine seems to be unnecessary. IT department of any company want to be smart and efficient to handle the growing requirements of the today’s business. Fortunately there is an easier way of doing this smartly; Slipstreaming refers to the process of creating a new bootable installation CD or network file for Windows XP installation which contains all the original operating system files, plus the latest Service Pack.
Prerequisites
You will need to have the following things in place before you start the slipstreaming.
1.Original Windows XP Pro / Home CD
2.Any CD Burner with the appropriate software for the CD cutting.(I have used Nero 6.0)
3.Window XP Service Pack 2, available from here
4.ISObuster for extracting the Boot Image from the original CD.
5.At least 2 GB of free hard drive space for a CD install file.
Slipstreaming Steps
The following steps are applicable for the Windows XP slipstreaming but with the little changes in the steps will also help you to do it for the windows 2000 (sp4) also.
Step 1:Create directories
First thing you must do is create a pair of separate directories XP-CD and XP- SP2 to hold the Windows XP installation CD and Service Pack 2 data in it.

The location of these directories could be anywhere on your hard drive but just remember the path while passing the update command later.
Step 2: Copy Windows CD Contents
Place your windows XP cd into your CD-Rom / CDRW and Copy all files and folders from the Windows XP CD to the folder created C:\XP-CD
Step 3: Extract the service pack files
Assuming that you have downloaded the right Service Pack 2 file,

We will move on to the next step of extracting the service pack files to the second folder XP- SP2. To extract the files open the command prompt by clicking START->Run->cmd

Then type the name of the service pack file with the –x parameter

A window will pop up prompting you for a location to uncompress the service pack files to. Enter the location of the 'C:\XP-SP2' directory you just created and hit OK. The service pack files will be extracted to that location.
You can also use the WinZip to extract the files to the specified folder.
Step 4: Updating the 'C:\XP-CD' directory with Windows XP Service Pack 2
In this step, we run the 'update' command built into each service pack with the 'integrate' switch, which will merge our Service Pack 2 files with the Windows XP install CD files and folders we copied onto our hard drive in the last 2 step (C:\XP-CD).
While still at the command prompt, type 'CD C:\XP-SP2\i386\update' to enter that directory

Then type the update command as 'update /S:(yourdrivename):\XP-CD' and hit enter to begin the update process. A window will come up and detail the install procedure.

Step 5: Extracting the Windows XP boot image from the CD
We need a bootable CD image file in order to create a bootable CD from our newly modified XP files. The Windows XP install CD already has a perfectly usable boot file; we just need to get at it. ISObuster is a free tool for accessing and extracting files from CDs and CD images.
ISObuster software is available here.

Insert your Windows XP install CD into the drive and open up ISObuster. Navigate to the 'bootable CD' directory. In the right hand pane, highlight 'Microsoft Corporation.IMG'. Right click it and select 'Extract Microsoft Corporation.IMG' Extract the file to your 'C:\XP- CD' directory.
Step 6: Create the bootable Windows XP Service Pack 2 CD with Nero Version 6
Now its time to create the fresh new bootable cd with SP2 integrated. To do this I am using Nero 6 but you can also use other cd writing software like Roxio Easy CD.
-> Start up Nero and select 'CD-Rom (boot)' as the type of disk you wish to make.
-> From the 'boot' tab, change the image file to the 'Microsoft Corporation.IMG' file that you extracted from the XP CD in the last step. (Note that you will have to change the 'files of type' box from '.IMA' files to 'all files' in order to locate your file in its directory.)
->Check 'enable expert settings.' In this section,
->You will need to change the 'kind of emulation' dropdown box to 'no emulation' and the 'number of loaded sectors' value to 4

->Now change to the 'ISO' tab.
->Change the 'file name length' dropdown box to 'max. Of 31 chars (ISO level 2)' all boxes on the screen should be checked.
->It's essential that the version of Nero you are using supports the 'do not add the ";1" ISO file version extension' option, or the CD you create will not boot properly.
->If you have an older version of Nero, you will need to upgrade to version 5.5 or newer.

Now click New Button to open Nero CD Content Explorer.In the file browser to the right, navigate to your 'C:\XPCD' directory and expand it. Now select all of the files and folders in the far right pane and drag them into either of the blank panes to the left. Delete 'Microsoft Corporation.IMG' file in the left window, since it is not needed on the CD.

Now click the 'burn' button on the toolbar and check the 'write' and 'finalize CD' options before burning the CD. Now you can use your newly created disk to install Windows XP with Service pack 2 already installed!
Legal Issues
Please note that while you can use the streamlining method to create an updated version of your own Windows XP CD with Service Pack 2 installed, this does not give you the legal right to use it on more than one machine at a time. A Windows XP license can still only be used on a single system at a time, unless you are using a volume license. OEM licenses (versions of Windows pre-installed on assembled computers) are considered to apply only to the computer they are first installed on, and may not be transferred to other systems. Be aware of these issues when preparing and creating your new CD.
Important Links
Windows XP Service Pack 2
http://www.microsoft.com/downloads/details.aspx?FamilyID=049c9dbe-3b8e-4f30-8245-9e368d3cdb5a&DisplayLang=en
IsoBuster
http://www.smart-projects.net/isobuster/