This happened to me after hard drive replacement under the Seagate Drive Recall at the local Apple Store. Here's what I learned from the process:
I Wagged the Mac home, fired it up (with naked OS installed at the Apple Store), and it wouldn't see my Time Machine drive with Setup Assistant - not on firewire 800 nor USB. Just a grey spinner that lasts forever. When I try just continuing anyway, it offers me something that looks plausible, but then puts up a dialog about duplicate user name, and no matter what I enter, it always says "that user already exists". So I think - maybe Migration Assistant. Complete the setup, create an account, watch the nice welcome movie. BAM - there's my Time Machine drive on the desktop. OK - it has to work . . . but no. Same behavior in Migration Assistant, plus the new OS offers to start making backups on my Time Machine disk - it's not recognizing it at all.
So - back to the Apple Store - let the genius figure it out. It turns out there are multiple problems. First, the "genius" who imaged my new machine picked 10.7.2 but my machine had 10.7.5 - turns out, it's not enough just to have right cat. Even a point release older OS may not recognize a newer Time Machine drive. The guy at the desk said "We have images of everything but the 10.7.2 has free iLife in it, so they like to use that one". What the heck? They don't image what you had originally as a matter of sane process?
Having figured that out, we re-image 10.7.5 at the store thinking we've fixed it. But no - Setup Assistant still won't see the Time Machine drive. Not on USB, not on Firewire. Not in a box, not with a fox.
So here's the second trick - newer machines have a recovery partion. see: http://www.apple.com/osx/recovery/ Boot with the option key held down, pick that partition, then you'll get a "system restore" option, to restore your whole system from a Time Machine backup. My drive was recognized by the recovery partition restore process when neither Setup nor Migration Assistant would. Obviously, there's something broken in Setup/Migration Assistant.
Takeaway:
- if you're getting a drive replaced by Apple, make sure they image *exactly* the same OS
- if Setup Assistant fails, use the recovery partition for system restore
- Use Recovery Disk Assistant http://support.apple.com/kb/DL1433 NOW to make yourself a recovery thumb drive just in case. With Apple's new "no media" approach to the OS, you're hosed without it.