as regards sp3, I installed this some months ago and it seems ok (fingers crossed). I'm assuming - perhaps wrongly - that since this install you have not been on the net? Because usually as soon as a recently installed xp goes on to the net updates start to download, mind you I always leave mine on automatic download. I would personally go for sp3 after back up.
re back up, I use an external hard drive and acronis TI, obviously there are other programmes that others recommend. Might be worth firstly backing up the pc as it is, then download software/updates and back up again. I tend to use cumulative back up, others do a fresh back up each time. HTH