While it's true energy is always conserved, kinetic energy is only conserved in perfectly elastic collisions. So, you are on the correct path at the end- inelastic collisions kinetic energy is converted into other types of energy, like heat, sound, deforming the bodies, etc.

If kinetic energy was conserved in the collision, then you would have the situation where the two objects bounced off of each other, and went in the opposite direction, at the same speed they came in.