Rodney,
1. The thumbnail thing is for Video Thumbnails. When you run preview are they video or stills of the first frame of the chapter? I have the stills in the menu I created and don't know how to remove them. Perhaps insert some colour boards at the start of each chapter.
2. When you create a menu from scratch by selecting New the Menu Designer opens in the Main Page with the My Videos title and 3 items which are place holders for the Play, Menu and Subtitles. If your project does not have subtitles then Item 3 is not used. If you then go to the Chapter page it opens with one button and Item 1, which is the text place holder for the first chapter. Don't worry about the button layout at bottom left -just add as many buttons as you need. Move/resize/modify them as you wish. Select OK to save your custom template. Then you can author the project. If your custom template has 3 buttons on the Chapter Page then the Button Layout at bottom left will show 3 buttons, not a choice of 1,2 or 3.
I don't know if it is possible to create your own menu with a selectable number of buttons. I suspect that the Menu Design feature in PD7 does not offer all the options that are seen in some of the standard templates on offer. If one of these has a special feature that you want, try modifying it to suit.
The issue of menus has been discussed in several threads on this forum over the last few months and there is a lot of information there if you do a search.
Regards.
Roger.