Many thanks to Graley Herren for helping me to appreciate the sexual innuendo in "Highlands". For full details, see his book Dreams and Dialogues in Dylan’s "Time Out of Mind."
Some six minutes into the song, Dylan's narrator stumbles into an empty cafe, leering at the waitress, with no idea what he wants. She looks at him dismissively and says "You probably want hard-boiled eggs," as in 'you have no huevos and you need to get some'. When he agrees and asks for them, she says nope, you won't find your manhood here. She also says "you picked the wrong time to come," suggesting premature ejaculation.
The waitress then demands that he perform as an artist, by drawing a picture, but the narrator protests that he can't do it, so she gives him a napkin and says "You can do it on that." In other words, he might as well masturbate if he can't perform.
The narrator then protests that he can't find his pencil, as in he has no balls and also no clue where to find his penis. Apparently, the waitress has been keeping it behind her ear so she hands it to him. Doing his best with the borrowed penis, the resulting performance is disappointing: "That don't look a thing like me."
The song reminds me of the sexual innuendo in "Ballad of a Thin Man," but now Mr. Jones is played by Bob Dylan. There are also a half dozen jokes in the song about how old the narrator his, and a few references to other Dylan tunes, like "Man in the Long Black Coat".