"This picture show how valve materials work.

1) Mesh is assigned to materials in a 3d Editor,
2) Material Names are written into the model from the 3d Editor used when the model is exported.
3) These material names must be used as your VMT names (if material over rides are not used)
4) When the model is compiled, the material path is written into the model by the qc.
5) If you have Texturegroups, the first texture in the group must be that material written into the model from the 3d Editor.
6) The names in the texture group for the next skins must be in the same order as the textures listed in the first group. These names are the names your VMTs must be named.
7) Paths and names for textures he model uses are written into the VMT (basetexture, bump/normalmaps, phongtexture, etc)
8) When the model is loaded into game, the model calls the materials (VMTs) from the paths based on what was written into the model by the 3dEditor and the QC, the VMTs call the Textures (VTFs) based on what was writtten in the VMTs.

"