What a coincidence.
just got an ipod classic for my birthday a few hours ago. Ran into the same problem - when you convert video in iTunes it does video only and looses the audio. (it's not smart enough to deal with muxing)

I already have Ulead Video Studio 10, and that has an option to convert video to and ipod format (MP4) so I used that. If you already have video editing software, give that a shot first.