How-To: Compress/Shrink/Compact (dynamically expanding) virtual hard drive files.
1/ Delete all trash, temp (Disk Cleanup, ccleaner, remove servicepack+hotfix uninstall)
(hibernation should not be enabled on a Virtual PC, use save state instead)
2/ Defrag (?)
3/ Mount “C:\Program Files\Microsoft Virtual PC\Virtual Machine Additions\Virtual Disk Precompactor.iso”
and run it.
4/ shut down the Virtual PC
Run the VPC2007 Virtual Disk Wizard
Virtual PC console -> File -> Virtual Disk Wizard -> Edit an existing virtual disk -> Compact it -> Replacing the original file

Reference:
HOWTO: Compress Virtual PC virtual hard disks (.VHDs)
Compacting a Virtual Hard Disk
prepare virtual hard disk file