You should be able to point the icon folder to any location that has item icons in it, provided they're compatible graphics files (.png, .gif. .bmp). It won't work with the straight .tga or .dds dragitemxx files from your EQ game folder.
If you have your icons separated out into subfolders of the icons folder (blunt, slash, shields, etc.), the icon picker will sort them into categories in a drop-down for you.
If you need separate .png icons, one of the earlier releases included the item icons up through Secrets of Faydwer, separated into categories.
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