Windows XP Upgrade disks don't require you to actually install the previous version of Windows.
You should be able just to boot VM from the Windows Upgrade CD, at some stage it will ask you to put some previous Windows version CD into the drive to validate your Upgrade license, so just eject Upgrade CD from the VM, put ME CD, wait for the installer to confirm its version and connect the Upgrade CD back to VM. Please mind that initially you need to create Custom or Typical VM with Guest OS type Windows XP, not ME.