Welcome to CDFreaks fakeplasticbuzz (is that a play on a Radiohead song?)
According to this site,
it sounds like you are performing the correct procedure. Now, I've read somewhere that iTunes has complete control over how it arranges the files and folders under Windoze and what you see under Explorer may not, in fact, be the real file location. According to the site above, you can verify this by Edit|Preferences|Advanced tab.
There may also be some other aspect in the iTunes configuration that's preventing conversion/storage. Again, look under Edit|Preferences|Import tab to verify that you are encoding the files properly.
Sorry I can't help more, but it certainly sounds more like an iTunes issue rather than a drive issue because the drive is clearly working and supplying enough disc Table of Contents information for Gracenote CDDB to find the album.
If you can insert an audio CD, double-click on the track number in Explorer, and hear the music playing (through Winamp or MS Cdplayer), then it is definitely an iTunes issue.
Good luck, and if you find out anything further please let us know.