After some troubleshooting I was able to figure out the the Importer cannot handle file names with spaces.
I was using a QC file that had $body "Body" "Engineer Reference.smd" line in it. Studiomdl.exe can handle this because it has quotes around it. Once I renamed the file without spaces(Engineer_Reference.smd) and updated the QC then it worked. Also the importer can import SMD file names with spaces individually just not in a QC file.
Also the importer cannot handle materials with spaces in the name. For example I have "Glasses yellow.vmt" inside it points to "$baseTexture" "models\AOtest/glasses yellow" which points to "Glasses yellow.tga". Had to change the $baseTexture to "$baseTexture" "models\0ETQWAOtest/glasses_yellow" and TGA to "Glasses_yellow.tga" then it works.
Just wanted to let others know if they have issues or maybe support for spaces can added in upcoming releases.
BTW Great product. Real nice work.
Thanks for the info. I will fix both issues in the pending update to WW.