The HD DVD player connects to the Xbox 360 using a USB connection. All of the audio and video processing and output come from Xbox 360 itself. The unit can also function as a USB hub, with 2 ports on the rear. It also includes a clip for attaching the wireless network adapter to it, like on the Xbox 360 itself. The device also has an integrated 256 MB memory unit which is used for storage of HD DVD data and is accessible to the user for saving other data such as saved games.
The drive will play standard DVDs in addition to HD DVD titles; however it will not read Xbox or Xbox 360 game discs, Audio CDs or mixed media CDs. All Xbox 360 games continue to use DVD-9 media. No Xbox 360 with a built-in HD DVD drive was ever released.
Source: Wikipedia, "http://en.wikipedia.org/wiki/Xbox_360_HD_DVD_Player," available under the CC-BY-SA License.