I will try an explain in some detail... unfortunatley a teacher confiscated my keyboard and mouse 'cause i was playing after lightsout, so you have no pics, i'm afraid.
Ok, since i'm lazy, here is how to make a heightmap
http://users.1st.net/kimberly/Tutorial/lodterrain.htm
What i did, was count the number of lod squares along one side of my map (in my case 32, for the whole grid) and multiply that by 256, half the original heightmap tga file size in pixels.( = 8192) So, I resized the heightmap image to 8192 pixels (height and length) Thefore we now have 256 pixels per LoD Square, and saved it as a jpg (when i first saved it is a TGA file, it was 150MB

) And ended up with a 700kb file. Make it into a texture, select the LoD in question, and apply the texture. It should come up 4 times, one of the heightmap in each quadrant. Just texture window, and scale 2, 2, and it should fit like a glove

The picture might need flipping, just use PSP for that.
Then go into game, and the white should correspond with the high parts of your terrain, and the dark, the low. If all's cool, then you can texture your image, using the heightmap as a basis (EG the black line = a river, so mud tex there, the white is mountains, rock tex there ect.) i used stock mohaa textures, and balr14's excellent textures, and made them patterns in PSP, so i could just apply them with the brush
My paths are pretty stupid looking, but thats because my PSP skills are pretty low...
I hope some of that made sense, if not just complain, and i'll try again
Mj