I dont think this is 100% correct. AppleTV can output at 1080i - so it must be up-converting.
Yes, actually its 0% correct, and you are 100% right.
Of course the Apple TV upconverts...when you set it to output at 720p or 1080i, it will output at 720 or 1080 lines of resolution, respectively, regardless of the source material.
It accomplishes this through video scaling (upconverting), which is one of the least-understood aspects of video. For those interested, there is an excellent overview of the topic
here. To summarize a few key points: in theory, upconverting DVD players shouldn't matter, because when you feed a 480p signal to a digital (pixel-based) display such as a plasma or LCD TV, video scalers in the TV will upconvert the 480-line signal to the native resolution of the display--typically 768 or 788 lines in smaller panels, though increasingly we are seeing true 1080-line displays, especially in the larger panels. The only reason upconverting DVD players have a legitimate role is that
sometimes, but not always, the video scalers in the DVD player are superior to those built into the TV, and so produce an image with less artifacts and other distortions. Video scaling is quite complex and algorithm-dependent, and so to a certain extent you do get what you pay for when you buy more expensive scaler circuitry. This is why Oppo players are quite popular in A/V enthusiast circles--they are seen as offering some of the best performance bang for the buck. If money is no object, at the lunatic edge you'll find Denon's flagship SD-DVD player (the DVD-5910) for a mere $3,800, which sports a state-of-the-art Realta T2 HQV scaler chip (not to mention a chassis build quality that makes an M1 tank seem like a cardboard box)!
TV does up-convert to 1080i).
