Hi Stephen,
Hmmm.
Have you tried to re-associate the KDS with the KSDK a second time using the Help->Install New Software... clicking the Add.. button then Archive... button and browse to C:\Freescale\KSDK_1.2.0\tools\eclipse_update\KSDK_1.2.0_Eclipse_Update.zip ?
Re-start KDS and try again?
If yes and it is still not working, I did once have a customer with very old Java install (their company had a proprietary application that required the older version of Java to run) causing the installation and association to mess up like what you are showing. Once they updated the Java version they were good to go.
Please reference:
C:/Freescale/KDS_3.0.0/eclipse/readme/readme_eclipse.html
If the Java version is not the issue I would try total uninstall and re-install.
Regards,
David