Using tips in this thread as well as other research here are all of the steps I used to successfully upgrade Win2003 (32bit) VM to Win2008 (R1 32bit) VM. This was used on vSphere 5.5.
In-Place Upgrade Windows 2003 (32bit) to 2008 R1 (32bit) Notes
1. VMware: Clone Windows 2003 candidate server to a new VM
2. VMware: Disconnect network adapter
3. VMware: Increase C: disk volume by at least 20GB (must have 20GB free space)
4. VMware: Power on cloned machine
5. Win2003: Logon local Administrator account (no network available)
6. Win2003: Uninstall all unnecessary applications before beginning
a. Uninstall Backup Client Agent
b. Uninstall AntiVirus Client
c. Uninstall Management Agent
d. Uninstall VNC
e. etc.
7. Win2003: Restart
8. Win2003: C: Disk Properties > run Disk Cleanup
9. VMware: Optional snapshot server for baseline safety copy to resume here.
10. Win2003: Extend C: (Parted Magic ISO, or whatever method you like) to include new 20GB free space
11. Win2003: Restart (CHKDSK may automatically run)
12. Win2003: Validate functional OS (look at event logs)
13. Win2003: Uninstall VMware Tools
a. Uninstall VMware Tools
b. Uncheck VMware: Edit Settings > Options > VMware Tools > Advanced > upgrade Tools during power cycling
c. Restart
14. Win2003: Cancel PnP device manager driver Wizard
15. Win2003: Manage Computer > Device Manager > Base System Device > Uninstall
16. Rename PowerShell folder located at: %windir%\System32\WindowsPowerShell to 2003WindowsPowerShell
17. Win2003: Shutdown
18. VMware: Optional snapshot server for baseline safety copy to resume here.
19. VMware: Edit Settings > Options > Guest OS: change from Windows 2003 (32bit) to Windows 2008 (32bit)
20. VMware: Power on
21. Win2003: Cancel PnP device manager driver Wizard
22. VMware: Connect CD/DVD to Win2008 ISO
a. Note bug in vSphere client, you may have to close all vSphere client application sessions and/or restart your PC to connect to CD/DVD ISOs if you have had several connections during this session already
23. Win2003: Autorun.exe from Win2008 x86 ISO install DVD
24. Win2008 Setup: Select > Do not get the latest updates
25. Win2008 Setup: Standard x86 > Next
26. Win2008 Setup: Accept License Terms > Next
27. Win2008 Setup: Which type of installation do you want? > Upgrade
28. Win2008 Setup: Compatibility Report > Next
29. Win2008 Setup: Upgrading Windows … Gathering files …
a. Elapsed time approximately 20 minutes
30. Win2008 Setup: Automatic restart
a. Expanding files …
b. Installing features and updates …
c. Completing upgrade …
d. Elapsed time approximately 10 minutes
31. Win2008: Automatic restart
a. Boot Manager Menus
i. Earlier Version of Windows
ii. Microsoft Windows Recovery Console
iii. Tools: Windows Memory Diagnostic
iv. Windows Server 2008 (automatic selection 30 second timeout)
b. Please wait while windows sets up your computer …
c. Elapsed time approximately 5 minutes
32. Win2008 Setup: Automatic restart
a. Completing upgrade …
b. Elapsed time approximately 10 minutes
33. Win2008 Setup: Automatic restart
a. Please wait while Windows continues setting up your computer …
b. Elapsed time approximately 5 minutes
34. Win2008 Setup: Automatic restart
35. Win2008: Logon as Administrator
a. PnP pop-up Found New Hardware > Ask me again later
b. VMware: VM > Guest > Install/Upgrade VMware Tools
36. Put new system into production
a. Choose this fork if the upgraded machine will simply replace the original
i. Win2003: Shutdown original machine that you copied
ii. VMware: Enable network adapter
iii. Win2008: Confirm network properties (IP address, DNS, etc.)
b. Choose this fork if the upgraded machine will be an entirely new machine on the network
i. Win2008: Rename cloned computer (had you planned in advance, the VMware cloning Wizard will change the SID, name the machine to a new name, set network settings, etc. for you at the time you create the machine copy)
ii. Win2008: Change SID using Sysprep (will restart x2)
iii. Win2008: Rename computer
iv. VMware: Enable network adapter
v. Win2008: Set network properties (IP address, DNS, etc.)
vi. Win2008: Add to domain
vii. Win2008: Restart
37. Move computer to correct OU in AD, wait for AD replication
38. Win2008: CMD > GPUPDATE /FORCE
39. Win2008: Run Windows Updates (multiple restarts)
40. Win2008: Install required software
a. AntiVirus Client
b. Management Agent
c. Backup Agent
d. etc.
41. Win2008: Thoroughly test all applications on upgraded server
42. VMware: Snapshot manager (delete optional safety snapshots you made earlier)
Thanks to these threads for additional information:
http://williamfaulkner.co.uk/2013/02/server-2003-to-server-2008-upgrade-powershell-compatibility-error/
http://social.technet.microsoft.com/Forums/en-US/winserverMigration/threads
https://technet.microsoft.com/en-us/library/cc755199(v=ws.10).aspx