1) the category tags at the top define the categories themselves, the category tags that are children of the product tags define which categories the product is a member of.

I had some trouble with images when importing a file for products that already existed. It seemed that they would sometimes disappear as I detailed here.

Glad to see Lyle is on the case. It looks like it takes quite a bit of work to keep this module up to date as features are added and changed.
-C