The iPod classic is one of the better portable players. The Wolfson DAC is pretty darn good.
The DAC is a Digital-to Analog Converter. A higher quality DAC results in a better, cleaner analog signal. The analog signal out of the DAC is then sent into an amplifier, and then your headphones. All of this is done internally with an iPod. If you were to get an external DAC, you would also need an external amp. However, you don't have an option for a digital output on an iPod, so you can't use a DAC with it.