I would have expected IE on the ISA server not to be able to connect to any sites until I configured IE to use the ISA server as a proxy.
I get the same thing when I VPN in from an external address. If I look at the logs, I see from the URL column that all URL requests from the VPN client are shown by IP address not name. As soon as I configure the VPN connection on the client machine to use the ISA server as the proxy, I see names not IPs in the log.
The fact that names are being resolved to IPs means that DNS is working. I have 2 internal DNS servers which forward to the ISA server. The DNS on the ISA server is a caching DNS. It uses our ISP's DNS servers.