FOUND THE PROBLEM!! .. we're using the wrong image! BMW20062.ISO isn't for e46 or the older X5 systems. The one that will work is here:

http://torrentspy.com/download.asp?id=626299

This is the one that was hosted on m3forums.com. Its 3 rar files that extracts a MDF file. You can burn the MDF with Alcohol 120% (has a free trial)

good luck!