Enjoy the Music.Com reviews Squeezebox 3
This is a good review of the features of a Squeezebox, and discusses the benefits of using an external DAC and a slightly upgraded power supply. The typical Squeezebox installation looks like this:
I agree with reviewer that using an external DAC is the way to go. The Squeezebox 3 (SB3) has incredibly low measued jitter, approximately 65 picoseconds. Using a S/PDIF output to your external DAC may introduce added jitter, and hopefully your DAC has good jitter rejection.