The directory module presents a very simple and lightweight hierarchical 'directory-like' view (conceptually similar to DMOZ, Yahoo, etc.) of nodes that have been assigned to one or more designated taxonomy 'vocabularies' (depending on module configuration). This allows users to drill down on selected content on your Drupal site.
If you have a site with taxonomies already in place, and/or you are not using the category module, this module may be a simpler approach to hierarchical navigation - just drop it in, configure, and go.
If you want more sophisticated functionality, you might want to check out the category module or other alternatives. If you have a suggestion for a feature that fits within the limited scope, by all means, please submit a feature request.
Drupal 6 version vs. Drupal 5 version
Directory.module for Drupal 6 is in many ways very different from the Drupal 5 version.
The main difference is that with Drupal 6, directory module does not handle the display of nodes anymore. It now relies on core's taxonomy module to do the job.
There are two implications:
1) The paths like directory/nnn where nnn was a term ID no longer exist. Instead, the main directory page links to taxonomy/term/nnn pages.
2) The first point means that the way the node teasers are displayed has completely changed. In D5 directory, the node display was broken at best. In D6, we rely on taxonomy to display teasers just like they would be displayed on the front page.
The taxonomy page is themeable, so if you wish to have a different look for the node listing, you can change it at the theme level. See the theming documentation about this.
The work for a stable Drupal 6 release of directory is still ongoing. There are still some serious bugs to fix, and new cool features to be added. D6 directory is still in alpha stage. However, it should be stable enough to use on a small site with not too many taxonomy terms.
You are welcome to test the new Drupal 6 alpha release of directory.module and use the issue queue to report any problem.
Presentation is everything. Unfortunately, one type of presentation does not suit everyone, because each vocabulary is different. Some are flat, some are hierarchical, some have many, many terms, some very few, some have a variable number of levels and sub-levels, some only have exactly 2 across the vocabulary, etc.
To suit different needs, we plan to add several theming options for each vocabulary. The plan is to keep directory lightweight, but with a choice of presentation styles to suit most needs.
The Drupal 5 version of directory is no longer supported at all. The code is too poor to be maintained. Huge parts of the module have been rewritten and it will be too difficult to backport fixes and new features to Drupal 5.