forums.wsusoffline.net

Thinking that there must be a problem with the Windows install I did a fresh install and tried again... Same Result.

How did you do the fresh install? If you used the Acer recovery media (or factory recovery image) you may have gotten all that pre-loaded crap again.

If you can't even install SP3 manually, there's something wrong with that system.
You won't be able to use WSUSOU in that case because
1. It requires the system to be on SP3, and
2. for exactly that reason, installing SP3 is the first thing it attempts. And if manual SP3 install fails, so does WSUSOU's attempt.

I don't know if that's possible, but you could try installing SP3 in Safe mode.

Please have a look in here:
http://support.microsoft.com/kb/949377/en-us

Some older versions of the Adobe Reader were known to lock some keys so you couldn't install newer version of the Internet Exploder. May be a similar case here.
Is the XP installation media clean - i.e. unaltered, non-modified - or is it a recovery media with pre-installed stuff?