Actually, Divx is a lot less compatible (and not nearly as good as H264) so I’d stay away from it.
I would also recommend you convert to MKV files if compatibility with other devices isn’t an issue (the Live likes MKV a lot better and it offers advantages such as DTS which MP4 files do not). Handbrake converts just fine to MKV files.
You can still insert your images into the same folder as your MP4 files (just with the same name but a JPG extension) and the Live will display them as thumbs. MP4 files can also have the thumbs embedded (the one and only advantage over MKV files) but you will need to do this in a program such as iTunes.
