I hope this help clear some things up,
1. What is a .dds file? a dds file is a image format used alot on older game engines and was one of most used image files in morrowind (along with many other games)
2. How can I open a .dds? I'm sure if you looked around you could find a plugin for photoshop or maybe Gimp to import/Export a .dds but if you run out of luck you can still use blender, to do this you would: open blender --> UV/Image Editor --> Press the "Image" Tab --> Open Image. and find your .dds file
3. why does it have 2 image files in it? are they different or is it needed? I Honestly dont think it even needs the .dds as the .dds and .png are of the same image. What i would do is what Fatality said just erase the .dds and if you have any problems with it not loading the any textures after that then go into the md5.cfg and change any texture that is loaded as a .dds into a .png and get rid of all the >dss> spots (note the greater than signs will be facing outwards i just cant show it here cause the forum page will think its a code and clear it out)... but i would only go into the md5.cfg if your having problems
Hope that Helps. Cheers! A_W_O_L__