Drive Copy 2010 SE - "not enough free space to expand virtual disk"

I select "Migrate from a Physical to a Virtual Machine".

Source disk is 37.2 Gb NTFS
Destination disk is 232.8 FAT32 (173 Gb free space)

Select MS Virtual PC option & "pre-allocate all disk space"
Select "Adjust OS to virtual hardware"

Copying starts and then after about 10 minutes this message appears:
"Insufficient disk space.
Not enough free space to expand virtual disk.
PLease free some space on the volume where virtual disk container resides to continue the current operation."

I'm copying a 40Gb drive to 173Gb of free space.
Why am I getting this message?

 

limitation of fat32, i think
http://support.microsoft.com/kb/314463