Please explain this to me...

The 1200 calories a day already has a deficit included in it. They want you to eat back your exercise calories so you do not create an even larger deficit. That can cause you to go into starvation mode and stop losing weight.

Your 1200 calories/day already has a deficit built in to lose whatever amount of weight you selected per week, just based on your normal daily activities - it doesn't include any calories burned while exercising. Exercise calories are extra, above and beyond the deficit you already need to lose the weight you want.

Example - if I regularly burn 2200 cal/day without exercise and I want to lose 2 lbs /week, MFP will tell me to eat 1200 cal/day. If I burn 500 cal/day in exercise, Then I would be burning 2700 cal/day - if I didn't up the calories I ate, then I would have a net loss of 1500 cal/day, or 3 lbs/week. It's generally not recommended you lose more than 2 lbs/week on a regular basis unless you are under strict doctor's care.

It's a bit of a debate - some people on this site regularly eat all/most of their exercise calories and experience great success that way, others have tried and say it doesn't work for them, so they only eat a little of their exercise (or none). Personally, I think that if you're working out and burning a lot of calories, then you need to eat some extra calories (at least some of your exercise calories) to fuel your body - the 1200 calories is just what you need to fuel your "normal" daily activities. But...that's my opinion. You will have to experiment to see what works best for you.