Ok, scratch my last. I would created a new client package and looks like everything works. Was able to capture my image as well.
Still would like to know more about the SMSMP if you get a chance, I will still try to google and find more as well.
Also I am still getting these errors in SMSTS.log - 401 - Authentication failure on request with anonymous access, retrying with context credentials. ApplyOperatingSystem
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From the SMSTS.log
Downloaded file from http://Server.FQDN.local:443/NOCERT_SMS_DP_SMSPKG$/MVH0004D/sccm?/autorun.inf to C:\_SMSTaskSequence\Packages\MVH0004D\autorun.inf ApplyOperatingSystem 7/30/2013 7:10:23 AM 1504 (0x05E0)
401 - Authentication failure on request with anonymous access, retrying with context credentials. ApplyOperatingSystem 7/30/2013 7:10:23 AM 1504 (0x05E0)
401 - Authentication failure on request with context credentials, retrying with supplied credentials. ApplyOperatingSystem 7/30/2013 7:10:23 AM 1504 (0x05E0)
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MVH0004D is my Apply Operating System Task