Sips, your understanding is correct that the 354 would run an analog stereo input through its ADC/DAC in order to apply bass management in the digital realm. The rest of your discussion, however, appears to be based on a faulty premise: that the DAC in the player would somehow be audibly superior to the one in the receiver. DACs these days have advanced to the point that the small measurable differences which exist aren't of audible significance. Nothing appreciable is "lost" by the HK. Use the digital output of the player and don't worry about trivialities.
