The phrase was made famous in an influential essay[0] by Richard P. Gabriel, where he laments Lisp's relative failure to compete with Unix.
In Gabriel's opinion, Unix proved to follow the more adaptive design strategy in certain ways (in spite of his involvement with and admiration for Lisp), and the phrase "Worse is better" is meant to capture the essence of that advantageous strategy (as outlined in the essay).
The essay is worth reading and is a bit more elaborate than just saying "less is more", or "keep it simple, stupid".
"Worse is better" comes from an ancient story where the Lisp folks were trying to design an elaborate system for resuming interrupted syscalls, and the UNIX folks just returned a "we fucked up" error to the caller instead. People take different lessons from this. Personally I feel like this is one of the earliest software forms of YAGNI: the (lack of) severity didn't merit the engineering effort to "fix" it. But, OP's interpretation is also valid.
> It refers to the argument that software quality does not necessarily increase with functionality: that there is a point where less functionality ("worse") is a preferable option ("better") in terms of practicality and usability.