Ahh, right, read part of your post and had a coworker come over, so I missed the part about starting with a new library.

The dialog is a bit weird in the way it's worded compared to what happened. I probably would have hit cancel myself. And I do wish that the whole iPhone syncing wasn't tied into iTunes. OS X had a perfectly good framework for this kind of stuff with iSync, and it works great with nearly every phone and Palm PDAs out there except the ones from Apple.