This is where I learned how to do it: http://deadlystream.com/forum/topic/1626-transparent-character-issues-look-here/?hl=transparent
Anyways, in this video I review the 2012 texture improvement mods for Kotor 1 by XediiXarwarz. But the main reason why I made this post is because some people aren't good at following picture and text instructions. So I made a video of how to do it step by step. Skip to 3:00 if you want to know how to fix the issue: