Requesting input from iMac users

I have been playing my iTunes library through (into) the main system via a Toslink coming from the headphone jack on the iMac to the input of the Krell HTS 7.1 processor. It sounds good to me, however, a friend is telling me that this is the lowest quality option for playing the music. According to him the headphone jack is putting the music out through a very inexpensive DAC in the iMac thus diminishing the quality out and causing the processor to accept the music via analog, converting to digital and then back out again in analog. A series of distortion causing steps.

I do have a Pop Pulse (never used) that would allow for coming out of the iMac via USB into the Pop Pulse and back out with digital cable (SPDIF) to the processor. Apparently this eliminates some extra DAC conversions. Would this be a better option? How do you do it?