I haven't had this issue with vlc 1.0.6 in Lucid. Marking as fixed.
There is also a workaround from
http://forum.videolan.org/viewtopic.php?f=13&t=53415#p191217
I used to have this problem and solved it by disabling desktop effects.
If it doesn't solve, try "sudo renice +1 <vlc pid>"
** Changed in: vlc (Ubuntu)
Status: Incomplete => Fix Released
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vlc 0.9.4 slower than 0.8.6 - video freezes then resumes pixelated for a few
seconds
https://bugs.launchpad.net/bugs/308385
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