
Apparently this is not overtly meant to be a drawing of the bunny's "little Bugs", but rather what looks to me like a subversive little joke intended to entertain the Looney Tunes' creators and their bookies. Officially this is a drawing of the negative space between Bug's legs shown as that towel slips down, but some see it differently. As a still frame it can be read either way, due to the artist's inclusion of the gray area on the inside of Bug's skinny little thigh there.
Here on Snopes.com is the full story, as well as a link to a video of this scene.

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