Similar to that's what she said, but more general.
To take whatever was just said, and think about it in a sexual tense. Often both highly amusing and crude.
A novice will point out the obvious, like "That's really hard." Wombat.
A master will put twists on the unexpected, like "When was the last time you washed this? It smells horrible!" Wombat.
(While John is doing homework)
Jim: "Hey man, what's up?"
John: "Would you quiet down? I'm trying to finish!"
Jim: "WOMBAT!"
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Student: "This test is too hard!"
Teacher: "Just shut up and take it."
Student: "WOMBAT!"
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(Talking about a car)
Mechanic 1: "It pulls a little hard to the right, but is still a really nice ride."
Mechanic 2: "WOMBAT!"
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