What does "An entity has timed out" mean?

Based on a post on the official game forums that text is a fail-safe message that was added in version 1.1.

Basically, the general idea is that due to either lag or button mashing it is sometime possible to interact multiple times with an item that you should be able to interact with only once: a common example is picking up an item by mashing the pick-up button. At that point the client triggers multiple "pick-up item" messages to the server...but since the server obviously knows that you can "pick-up" the item only once, the other attempts receive the aforementioned error message.

Note that apparently this was a thing in previous versions too - you were never able to trick the game and pick up an item multiple times, simply previously the error was silently ignored with no feedback: all that v. 1.1 changed was adding a specific message for the user.