VLC player slow and laggy playing mkv files

MKV files are laggy in the VLC player and even avi videos are a little slow. I used to have XP and onboard ATI X200 graphic card and those laggy videos worked fine. I have upgraded to Win 7 and upgraded my memory from 1GB to 1.5GB and video card to the ATI 3650 HD PCI-E with 512MB DDR2 128bit card (originally from a HP comp.). I did the hardware upgrades since the videos became laggy after installing Win 7. After the upgrades I was able to get media player classsic HC to play MKV files w/o subs fine, but it becomes laggy (like VLC) as soon as the subs are turned on using Directvobsub. VLC is still slow with all mkv's.

Anyone have any idea how this can be fixed? It would be great if VLC can be fixed because it's one package.

My system is:
Win 7 Ultimate 32-bit
AMD Athlon 64 Processor 3700+, 2.2GHz, 1 core
1.5GB DDR memory
ATI Radeon 3650 HD 512MB 128 bit (w/ ATI catalyst 9.12)
btw, VGA out goes to my LCD TV

let me know if you want more info