The AppleTV is primarily acting as a network media client, similar to a SqueezeBox, but you can physically copy portions of your iTunes library (via wireless or wired network) to the device's hard drive (they make a 40GB version and a 160GB version). As for how it sounds, the biggest factor is the files themselves: lossy compression (be it MP3, AAC, or whatever) is still lossy, but a lossless solution (be it WAV, Apple Lossless, or whatever) should be able to match the original CD. I don't know that the AppleTV / iTunes support for lossless formats is particularly good (limited to just wav and Apple Lossless, I think), but for someone who is already using an iPod as a significant audio source the file library would port over directly (including any DRM'ed files bought through iTunes).