Externally referenced photos
Normally, when you import photos into an iPhoto library, iPhoto makes its own copies of those photos and stores them inside the iPhoto library. This makes the library self-contained, making it easy to copy or back up, and lets iPhoto worry about managing the locations of the photos itself.
Some people need more flexibility than this though, so iPhoto offers an option in its advanced preferences labelled “Copy items to the iPhoto Library”. This is on by default, but if you turn it off, then when you import photos into your library, iPhoto will create aliases that point to those photos in their original location, rather than making its own separate copies of them. This can be useful if you need to store photos on a separate drive or more easily access them from another program. These are often referred to as “referenced” photos, and photos stored inside the library as “managed” photos.
iPhoto Library Manager understands and deals with referenced photos, so you can view and copy such photos just fine using iPLM. However, when you use iPLM to copy photos to another library, whether it be using the merge or rebuild commands, or by dragging and dropping individual albums, events, or photos, those photos will always be copied into the destination iPhoto library (i.e. as “managed” photos) regardless of whether the photos are managed or referenced in the library they’re coming from. This behavior is intended to minimize the chances of doing things like accidentally deleting the only copy of a photo when you think that you actually have multiple copies in different libraries. You can also take advantage of this behavior, e.g. by using iPLM’s rebuild library command to convert an existing “referenced” library into a new “managed” library.