Greetings, Utu.
in my case:
options --exclude *gvfs* prevents the error messages to complete KNOPPIX1 creation options --exclude *cache* is to reduce size of KNOPPIX1
I had already set up by default to move cromium cache, ~/.thumbnails, proxy cache to ramdisk.
option -iso-level 4 is to prevent file/directory name truncation as you can see at the beginning of the process of mkisofs.

Code:
cd /
sudo mkisofs --exclude *gvfs* --exclude *cache* -iso-level 4 -R -U KNOPPIX-DATA | create_compressed_fs -B 131072 -m - - > /mnt-system/KNOPPIX/KNOPPIX1
I'm testing KNOPPIX1 without overlay at the moment and everything goes well.
The size of KNOPPIX1 is only 720MB instead of 3GB overlay (2GB really used)
With KNOPPIX1 ramdisk is used by default by knoppix