I can reproduce the behaviour you described in KDE 3.5.10, so it did exist at some point but may now have been fixed (or not). However, I should probably note that I get the "Extract" option replacing "Compress" only if all the files I select are recognized as being compressed--if I select, say, two .zip files and a .txt, the "Compress" option remains available.
What you describe rang a bell. I tried a directory only with compressed files. I still can't repeat the problem here with either 3.5.10 or R14_GIT. My head hurts. :)
Darrell