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The same problem on Max Os X snow Leopard:
[2011-02-23 10:27:02 - Dex Loader] Unable to execute dex: Java heap space
[2011-02-23 10:27:02 - ArcGIS_1] Conversion to Dalvik format failed: Unable to execute dex: Java heap space
Increasing heap (up to 1gb) does not help.
You also need to change the start, fixed and maximum values of heap:
edit 4 values:
-startup .... --launcher.XXMaxPermSize 512m ..... -XX:MaxPermSize=512m -Xms512m -Xmx1024m .....
I had the same issue and could fix with increasing the vm. but I could not go up to 512 and 1024