the following is direct from Microsoft's Technet website
The System Preparation tool (Sysprep) is a technology that you can use with other deployment tools to install Microsoft Windows operating systems with minimal intervention by an administrator or technician. Sysprep is typically used during large-scale rollouts when it would be too slow and costly to have administrators or technicians interactively install the operating system on individual computers.
You typically use the Sysprep tool in conjunction with a non-Microsoft disk imaging tool or Microsoft Windows Server 2003 Automated Deployment Services (ADS) to perform image-based installations. Image-based installation is a method of copying or cloning preconfigured operating systems (and, optionally, software applications) onto destination computers. After you set up a master installation — an installation with the operating system, software applications, and configuration settings that you want to install onto the destination computers in your organization, Sysprep prepares the master installation so that you can create a disk image; that is, a functionally identical replica of the disk containing the master installation, that can be copied onto multiple computers. The disk-imaging program creates the disk image of the master installation. After the disk image is copied onto a destination computer, and you start the destination computer, a shortened version of the Windows Setup program runs. The shortened version of Setup configures only user-specific and computer-specific settings, such as computer name, domain membership, and regional options. You can automate this last part of the setup process by using an answer file, a simple text file that instructs the Setup program how to configure the various operating system settings.
Basically it allows you to "prep" a system for deploying the OS. - all the normal installation tasks are done automatically during the install so you can deploy the install and walk away.
One REAL world application -
Recently we used G4L ( Ghost 4 Linux ) to deploy 30 some odd machines. Each of these windows xp installs were identical.
Started the process by using an XP install
Added all of our 3rd party applications
Add printers and settings - security updates etc
then ran sysprep
to sum it up ... it configures the image for distribution in a way that it forces a shorter version of the Windows setup - which can be automated- so you can define "computer specific" settings
adding the computer to a domain etc.
If we had not used sysprep. Each machine would have identical computer names- they would all think they were the same member of the domain, and they would share the same SSID - which causes a large problem.