There are three slots. One for the monster you want to evolve, one for a chance at getting SS or S, and one for getting a mercenary that is already at high level.
You don't need three maxed levels merc to compound. Just one. The other two slots are optional. I recommend only using two though, one for the evolve slot and one for the skill up slot.
It only cost 1,000,000 zeny to compound. The spending of diamond is optional. Spending diamonds will only increase the chance of getting S or SS even more. It only cost 10 diamonds for this option. You just have to click on the button below the merc to initiate it.
This is a lot cheaper than spending diamonds on the golden draw which doesn't even guarantee a r4 merc.