Because it's still early in the show, this is mostly another exposition chapter. The characters have to get to know each other better, the viewers have to learn more about the world, and any additional characters from the main cast still have to be introduced.
This episode pulls it off well.
We join the gang as they make their way to Aang's home, the Southern Air Temple. Once there, Aang introduces the now deceased Monk Gyatso, and all three learn about Aang's past Avatar lives. It is also here where we get to witness Aang's Avatar State again, along with its awe-inspiring and dangerous power, except this time, it's official. And the world finds out about it.
Also beginning in this episode is the telling of two story lines parallel to each other. While the gang does their stuff, we also get to see Zuko and Iroh handling their own problems. These plots keep exchanging screen time, and their execution marks the excellent pacing of the show.
Back in the Fire Nation, we are introduced to Commander Zhao, formerly Captain Zhao, an arrogant man who loves his power. He's also voiced by Jason Isaacs, which is enough to make things awesome. The enmity between him and Zuko quickly becomes clear, even leading to an Agni Kai, a firebender duel. Just as a side note, the Agni Kai shows some pretty awesome martial arts and choreography.
Next to clearly showing the Avatar State, however, it is Zhao's entry into the cast which is the key in this episode. By having him join, it's suddenly not just Zuko versus the Avatar, but now there's a triangle relationship between the gang, Zuko, and Zhao. A free-for-all, and a great setup for interesting intrigues and character development.
We end this episode with Katara calming Aang down, and pledging that they are now a family, which means they'll stick together for the rest of the show. Good that that's clear. This is fortified by Momo joining the gang, giving Aang new hope, even though he's now lost his home.
I see this episode as the 'hooking' episode; if you were not hooked to the show before now, you will be hooked by the time you've watched 'The Southern Air Temple'. The cast is largely complete, the viewers know what's up, and now, it's time to start the action. It's off to a great adventure from here on.