Here's the list of supported file formats:
Video: MPEG1/2/4, WMV9, AVI (MPEG4, Xvid, AVC), H.264, MKV, MOV (MPEG4, H.264), Subtitle SRT (UTF-8)
Photo: JPEG, GIF, TIF/TIFF, BMP, PNG
Audio: MP3, WMA, OGG, WAV/PCM/LPCM, AAC, FLAC, Dolby Digital, AIF/AIFF, MKA Playlist PLS, M3U, WPL
Aside from the lag issue when loading files, we were pretty pleased with the setup. We played several video file formats on both a small 17-inch TV and a larger 50-inch TV. If you're dealing with a small TV, the picture looks pretty good whether you're connected via the standard composite (yellow) cable or HDMI, though HDMI will always look better. When you start to step up to bigger TVs and try to blow the picture up, you're limited by the quality of the file you are playing. The less compressed, high-resolution files will obviously look better.
In terms of compatibility, the WD TV Media Player was able to play back all the video files we threw at it, including some 1080p film trailers that looked really good. However, we had some trouble with audio playback from a couple of those files. In one case, the audio ended up playing back through the stereo composite cables but not the HDMI connection. In the other instance, audio wasn't available through HDMI or the composite AV cable. For the record, this was much more the exception that the rule, but don't expect it to play back every file under the sun. We tested the unit with the 1.01 version of the firmware; Western Digital may add support for additional formats with future firmware upgrades as well (just download the new firmware and copy it to a USB drive to upgrade).
Owners of the PlayStation 3 or Xbox 360 should note that those consoles already do a good job of media playback (via USB or over the network), but the WD TV might have some key file format support that those do not. Likewise, dedicated media streamers such as the Popcorn Hour A-110 (which has built-in networking capabilities for streaming files directly from your computer to your TV, and even a dedicated BitTorrent client) or the Sling Media SlingCatcher (which supports file playback via USB) may be more full-featured, but they're far more expensive as well. They also include some degree of network configuration, while the WD TV is more of a plug and play device.
As far as direct competition, the Iomega ScreenPlay TV Link is less expensive ($80-100), but the WD TV Media player is the sleeker looking device and has a easier-to-use interface. However, the Iomega managed to play the audio without a hitch on those two files the Western Digital player had trouble with. Meanwhile, at the time of this writing, Seagate hadn't quite released its FreeAgent Theater HD media player, but the two products are very similar and carry identical price tags. We doubt that model will have any significant advantages over this one, so if you're in market for this type of device as a way to free your multimedia files from your computer, we have no problem recommending the WD TV Media Player. While it may not be without its kinks or offer networking capabilities, it does what it advertises--and does it pretty well.