I had the same problem. Your flag graphic has to be transparent (notice how the game renders every flag image on top of its flag model).
This is how I do it:
- Convert the flag graphic to truecolor PNG with alpha channel
- Load the image in GIMP and use the eraser tool to "erase" your whole image
(in fact this makes your entire image transparent - I know strange!)
- save
- Use DDS converter (make sure to select the right options i.e. DXT3 + save alpha channel)
Hay thanx basket case, I was wondering why it wasn't working for me also. I used Photoshop and made a few good looking ones. What I did was made a brand new one at a size of 128x128 with a transparent background then converted it to *.dds with the option you sugested and it works.
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