I have to agree.
My 3-year-old daughter watched her little newborn cousin (I think, I can't be bothered to do the family-tree maths) have his nappy changed for the first time. You have never seen a child stare like that in your life, we were all in fits of laughter and she was transfixed, crouching over him "pretending" to help while actually she just wanted to see the thing she'd spotted straight away.
What would those parents have you do? Hush it up? Pretend it doesn't exist? Tell her off for being rude (she's THREE - how does she know that something she's never seen is considered "rude")? All courses of action that I guarantee you would leave her with a morbid curiosity about finding out what that thing is when Mummy/Daddy/Grandparents AREN'T around (and hence you end up with a pregnant 11-year-old or whatever).
To quote Kindergarten Cop (there's a line I never thought I'd say!): Boys have a penis, girls have a vagina.
What the big deal is in that, I don't know. Get over it. Your daughter could have called it a lot worse and at least she KNEW what it was. Now imagine how your friend's daughter is going to cope when she gets to secondary school where there's talk of sex and all sorts and she gets pressured to tell her friends that she knows what it all means, or to confess that she doesn't know at all.
Nudity is on page three of several papers, and you can spot nude women as soon as you're old enough to look up in a newsagents. Sex is a natural human function that, okay, maybe you might not want to discuss in public (at least, any more than other natural functions like the operation of your stomach and bottom on food, which is what my three-year-old is obsessed with at the moment and wants to share with the world), but there's nothing scary there and they WILL teach her it in school (unless you WANT to pull her out of that class and make a laughing exception to the rest of the class). Pornography - that's something entirely different and you might well want to hide that from children but even upon discovery? It's just pictures of people who "love each other" and "are having sex", depending on your outlook and acceptable "lies to children" factor.
I don't expect fathers to be dangling their appendages around the houses, but for feck's sake, it's a willy. Get over it.