State field's drop down does not update when the Country changes.

Woohoo! I figured out a solution. After trudging through the Location module codes, I found the offending lines of code (lines 311 to 315).

Originally, the code is as such:

if (!isset($element['value']['country'])) {
$country = $fdefaults['country'];
}
else {
$country = $element['#value']['country'];
}

I'm unsure how this could have at any point even worked, there is no ['value'] attribute in the array $element (it's #value, you can see this clearly if you dpm($element);).

The solution is to replace those lines with these:

if (!isset($form_state['values']['locations'][0]['country'])) {
$country = $fdefaults['country'];
}
else {
$country = $form_state['values']['locations'][0]['country'];
}

Understandably, this is more of a customized hack for my particular use case--if you require more than 1 location (and thus there are multiple ['locations'][#] sub-arrays), then this would break horribly.

Nevermind, this solution doesn't pass validation (I guess I counted my chicken before they hatched!). I did find another solution, I'll post it as a patch tomorrow once I have some time.