What does chess theory refer to? I hear some people say certain players only win because they know/memorized a lot of theory? I don't know the "official" term for these types of players but it makes me concerned because hopefully I'm not one of them. It makes it seem these types of players aren't good at chess or don't really use their head to play the game. Can someone clarify what this is all about?
Chess theory in this sense refers to opening variations / opening analysis. Every strong player has a repertoire of opening lines that he likes to play and in which he knows pretty well which moves are the best. 

Some players analyse the opening exhaustively and try to find tricky lines before they sit down to play. This is helped by the fact that they can look up games of their next opponent in databases. These players occasionally win games just by following their home preparation. 

But this is not something that should overly concern you. It's more of a grandmaster's problem. On the top level in chess opening preparation plays a big role. In amateur games it is usually easy to dodge any kind of special preparation by the opponent. 

It is easy to look down on people who spend a lot of time learning opening variations by heart, but in reality spending time on the opening also improves your understanding of typical position, tactics and plans. If somebody wins a lot of games in the opening, this is never just due to reproducing learned lines with no understanding. Chess is too complex and diverse for that.