We're supporting FAT32 because it's the most universally supported (and easiest to support).
Other filesystems will be supported in future updates, for sure. In the meantime, the management software will split the files automagically into .iso.1, .iso.2, and so on (or you can do this yourself).
Some BIOSes will, oddly enough, boot USB optical drives but not USB mass storage. No idea why, it may have to do with the fact that way too many USB flash drives have piss-poor SCSI command support (they speak SCSI Block Commands, USB is just used as transport).
We're really pushing for Mac compatibility. Mac firmware is very picky, for sure, it seems to have very strict requirements for SCSI command support on optical drives.
Resetting the USB controller and such are no problem for isostick, it will come right back up in the same state it was left in.
Excellent point that modern OSes don't need the optical drive functionality. I still use my isostick to carry around lots of OSes and switch between them with ease, though.
The isostick is also useful for some newer machines. Macs have a lot less problem booting images, as you mention.
I've found that even newer netbooks don't like booting from USB flash sticks, but will happily boot from optical drives (and thus, isostick).
Some utilities will only boot from optical drives as well, though this is less of an issue with newer utilities and OSes. Windows XP is a good example, which is still in surprisingly high use today.