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When I tried to update the firmware in my iPhone (not jailbreaked/modified/unlocked), it erased all the data, and said that it needed to be restored. i tried to to restore it quite a few times but that didn't work. Re-installing iTunes and restoring didn't work either. For the record, I tried this on a Win XP machine.
I uninstalled the iTunes s/w, deleted the iTunes folder in C:\Documents and Settings\\Application Data\Apple Computer and re-installed iTunes. Then, I could restore the iPhone and upgrade it with the new firmware 1.1.1. Of course, I lost the data on the phone.
Hope this helps those people who were unable to upgrade their "virgin" iPhone and got stuck mid-way.
Cheers,
Praveen