Just out of curiosity, why do you want to convert .mkv files to an inferior container like .avi?
Anyway, the latest BETA of MPEG Streamclip can do that for you.
With an .avi file I can add a subtitle using submerge and convert into a AppleTV file.
Handbrake has the option to add external subtitles to your .mkv and then transcode it properly. Have you tried that using the Apple TV preset?
Yes, I've already tried Handbrake. But it is not possible to setup subtitles (size, font,...) in Handbrake. Then the subtitle in the file doesn't fit well in the screen.
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I think what you're really looking for is MKVtools. It will take your MKV files and demux them, convert the audio to AAC and remux all without re-encoding your video! It literally takes about 10 minutes for a full length movie on my macpro.
It will also handle subtitles, but I havent messed with that feature in length.
http://www.emmgunn.com/mokgvm2dvd/mokgvmhome.html
Seems like you are stealing the content anyway, so you might as well download the Apple TV compatible version.