Circluar frame/mask with kgPanels - help me understand how?

[Shanyn]

So let's say I have a square unit portrait, and I'd like to make it into a circle with a thin border. Like this:


Can someone give me the basics on how I might make all the square corners and bits outside the circular texture transparent?

Note: I understand photoshop. Alpha channels, masks, all that stuff--I can make any TEXTURES I need for this without explanation. What I don't understand is the actual execution. How many textures I need, what to mask in which--it seems like I'd take a transparent texture and mask out the corners, but... if it's a transparent texture... wouldn't it do nothing?

I know it's possible; I have an example of a UI that does this (here), but I've looked at the textures in the art pack and still can't figure out exactly how.