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A factory reset reformats the phone's user-data partition, but it's not a "secure" wipe; it doesn't overwrite everything with zeroes. If you want to be sure everything is erased, you can encrypt the phone first (which overwrites all the data with encrypted versions of itself), then do a factory reset (which sets up a new unencrypted filesystem). Note that ...
No. Contacts' pictures are kept separately from the original photos you added them from. They're stored with the contacts database, not with the photos on the SD card. Deleting photos from the Gallery app or wiping the SD card won't affect them.
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