With this option, you're able to add subs as an extra track to the mp4 file. The subs aren't hardcoded, you can enable/disable them in VLC via menu "video" > subtitles > deactivate.
But sadly, the xbox360 won't recognize the subtitles. From what I've read it's an encoding problem of the subs and they need to be converted into a special format. As if this wouldn't be enough, you need to patch the converted subtitles again.

Maybe I'll add support for that in later versions, but only if it's actually possible :)

I'm glad it's working for you now (or isn't it?), I applied some fixes to the handling of paths.

Please provide more information :) Can you load the MKV into MKV4XBox, press the (get mkv info) button and give me a screenshot of it? You can upload it to tinypic or imageshack.

What's the actual size of the MKV itself?

Have you tried to use the original bitrates of the mkv file? You can do this by clicking get mkv info. The values will be set automatically.

Is this the case for any MKV file you try to convert?
If not, please provide specific information about the MKV file (make a screenshot from mkv4xbox with loaded infos and upload it)

Please answer the following questions:

1. Filename?
2. Path to File?
3. Target Path?
4. Size of the MKV?
5. You want to split (yes/no)?
6. Do you enter the values by yourself or do you use get mkv info
7. How long does it approximately take until you get to the error?
8. How big is the .ac3 file?
9. How big is the .x264 file?
10. How far does it go? Do you have growl installed? It shows you the current progress (converting, muxxing ... )

Please give me some details, otherwise I can't reproduce the error. I tried the tool with many MKVs under any circumstance (weird filenames and paths and so on) and it always worked out fine.

my email adress is stephan.linke[at]screamink.com

I'm sure we can fix this ;)