I wondered these things too - I'm a bit of a novice. Like the guys say, you can hack your appletv so that it'll play most things. If you don't want to do that (or like me you think it's a bit of a risk given my level of expertise), you can convert your divx, xvid etc files.
Best thing for converting is Visualhub, which you pay for, or there's a freeware program by the same company available. Visual Hub is pretty good, although it's not super-quick and some files just don't seem to work (although I didn't persevere).
Good luck whatever you choose - it's still a great product. My friends were so impressed they thought just the photo screensaver was the whole product!