I don't fully understand it... but basically where it references filename.png, if it finds a file named filename.png it will use that... if not it will look for a file called filename.dds and use that instead.
So basically, you can (and should) save your skin as mynewskin.dds, but you can put mynewskin.png in the xml and it will work fine.
That should work fine.
In your example in your first post, it will be using K_Male_Evil_Texture_01.DDS.