I have just followed the instructions for xp activation , entered a new code and it seems to have worked as it now says windows is now activated.
Firstly what does "activated actually mean"

Can I now update SP1 or what ??

Well if it says youve activated, then surely it must be! so go ahead and load SP1. Allthough on a recent clean install of XP i loaded SP1 before i activated with no problems whatsoever!

Activation confirms to MS that your copy is leagl and allows full functionalty of XP. Registration of the product is a seperate process and optional

well to my encounters ,i did a sp1 update ,an the whole thing keeped scewing me up ,like i would crash freeze up etc ,i refomatted 3 times ,clean install to sp1 an still no luck,but to my thinking ,i read about doing a slipstream cd,where u can copy ur whole xp pro ,an sp1 an aadd them together as 1 iso cd an to my knowledge ,sp1 dosent update ur system properly unless u do this,cuzz i didnt get any 2002 certified drivers on some hardware till i did a slipsteamed cd,there alot of step by step guides that show u how to slipstream combind a iso with ur copy of xp pro ,in websearch