Use Vidrop to convert the files. I have been playing with the same player as you.
It is definitely 4gb (I opened it and found a 4gb samsung chip) and it does play AVI files. You do need to convert them to the correct screen resolution with Vidrop though (320x240 at 22fps).
I am still trying to figure out how to repartition the thing to 4gb.
Here is my topic on the device...
Which low level format software? Full details. 4gb hacked to show 32gb.
This player is actually one of the nicer players I have seen. 4gb brand new MP4 for $27US is a good deal in my opinion. Shame about the hack hassle though but I knew it would be hacked as no one can sell a real 32gb player for around 30 bucks.
Buying and reselling these hack jobs has turned into quite a hobby for me although when I do resell them I make sure they are working great and that the hack is removed.