A conflict occurs when two independent changesets modify overlapping sections of a file in different ways. During a merge, Mercurial may require the assistance of the user through a merge program which can be used to resolve those conflicts.
If the merge program is not a graphical tool, a common fallback behavior is to use diff3 for highlighting the conflict in the file using conflict markers. A text editor can be used to resolve the conflicts manually.
Given the base file:
$ cat base A B C
assuming local is your modified copy of base:
$ cat local A B - my local changes C
and assuming other is another modified copy of base:
$ cat other A B - changes made by others C
then there's obviously a conflicting change on the B line. The "merged" content, as produced by the GNU diff3 program, will look like this:
$ diff3 -m local base other A <<<<<<< local B - my local changes ||||||| base B ======= B - changes made by others >>>>>>> other C