I think (not certain) it is the publishers that do the conversion - not Apple. They send AAC files to Apple using the iTunes Producer app.
http://www.apple.com/itunes/musicmarketing/
edit: hmm, it appears they can send in lossless also.
edit: http://www.losslessaudioblog.com/2006/07/01/apple-lossless-coming-to-itunes-producer-14/
Thanks for the clarification. It may differ depending on the scale of the distributor and whether or not they have any special promotions they coordinate wth iTunes, e.g. front page stuff...
But hey, I think I'm going to check this out. I have some material I was going to distribute on iTunes via CD Baby but if I can get on board through the producer program that would be better.
At any rate, though, I doubt that the labels even go back to the original master recordings. It really is going to be most convenient the majority of the time for them to just load the new releases through a CD. In some cases the record label doesn't even have the original master. It may be in the possession of the producer, recording artist or the studio that's archiving it on behalf of the client.