An extended stored procedure is a function within a DLL 
(written in a programming language like C, C++ using Open 
Data Services (ODS) API) that can be called from T-SQL, 
just the way we call normal stored procedures using the 
EXEC statement. See books online to learn how to create 
extended stored procedures and how to add them to SQL 
Server.

An extended stored procedure is simply a procedure that is
implemented in a dynamic link library (DLL) — a library that
is called by an application at runtime. Extended stored
procedures can be used in much the same way as database
stored procedures, except that extended stored procedures
normally perform tasks related to the interaction of SQL
Server with its operating environment. Tasks that are either
too complicated or just not possible using Transact-SQL can
often be performed with extended stored procedures.

Extended stored procedures are written using the Open Data
Services (ODS) API. ODS is written and supported by
Microsoft and is available on the Workstation version of SQL
Server and as a separate product (and in the Back-Office
Development Kit). The ODS development package includes both
a static-link library (Opends60.lib) and C header files that
let you create fully functional database services. ODS
applications are dynamically linked with Opends60.dll.

A DLL that contains extended stored procedure functions 
acts as an extension to Microsoft SQL Server. To install 
the DLL, copy the file to the directory containing the 
standard SQL Server DLL files (C:\Program Files\Microsoft 
SQL Server\Mssql\Binn by default).

To add each extended stored procedure function in an 
extended stored procedure DLL, a SQL Server system 
administrator must run the sp_addextendedproc system stored 
procedure, specifying the name of the function and the name 
of the DLL in which that function resides. For example, 
this command registers the function xp_hello, located in 
xp_hello.dll, as a SQL Server extended stored procedure:

sp_addextendedproc 'xp_hello', 'xp_hello.dll'