Ha, I was about to suggest AAA. They're great if you're already a member. I got my last photo taken at a mail receiving place--most private mailbox companies take passport photos. So Postal Annex, UPS Store, places like that.
I don't know whether the State Dept. would give you a hard time about the photo. If you think it's way too grainy, you might take it back to Walgreen's, along with the receipt, and ask them if they usually take such grainy pics. How does it compare with your current pic?
Blueconstancy is right on target about the letter. I got my first letter before the State Department published specific guidelines, so it didn't have the right information. In fact, it wasn't even the right kind of doctor, since the State Department doesn't include surgeons in the list of acceptable physicians. I was assembling my materials right when the new guidelines were published. So I had to start all over again and go to my GP. But it all worked out in the end.
A lot of people change or update passports without having any travel plans. I put down "none" for that myself.
You might actually prefer to submit your materials in person. If you think you might need particular documents but you aren't sure, bring 'em anyway. The people there can tell you whether you have filled everything out properly and submitted all the right stuff. But if you follow the directions to the letter, you ought to be okay. Maybe have a smart friend look everything over.