Before you convert the file, be sure to check the proper options at the top of the window.
First, make sure that you've checked "Optimize for iPod" and then select the "H.264 Encoding" checkbox, as that's the high-quality iPod video format.
Lastly, you can determine the quality of the encoding. The better the quality, the larger the file, of course.
Once you've selected these options, click the "Start" button att he bottom of the window.
