Its the state at which the body is using fats as its primary fuel source. As a byproduct of using the fuel ketones are created. Since the body is now a primed to burn fat as fuel when doing cardio or dieting ect.. the body is less likely to turn to muscle catabolism to aid in its energy crisis instead it is more likely to turn to burning bodyfat since its gears are already shifted towards using that type of fuel. This is why it is said that ketosis/ketones are muscle sparing.
You still need the calorie deficiit in order to lose weight but the reason that it is considered so effective a way to diet is because it helps ensure that the calorie deficit is made up for by using a larger percentage Fat rather than muscle compared to other dieting means.