Just went through this procedure. Firmware 1.08. One of drives in RAID1 (infamous WD green 15EARS) failed. Rebuild failed as well. SMART utility showed bad sectors and suggested RMA.
When a brand new replacemet HDD arrived I popped it into the box, started it and was asked to format the drive. After I pressed Format button almost immediately (at 1%) 'Format failed error 107' message appeared.
Whatever I tried to do - swap drives, skip initial prompt and start format manually - the result was the same :-(.
Finally I detached "good" HDD, and started NAS with new empty drive only. NAS recognized it and offered to format it as a single. I ageed and it started formatting it with no problems. At 30% I ABORTED format, shutdown NAS, plugged back first healthy drive and restarted the box. Now NAS recognized back that there is a degraded RAID, showed second (new) drive as FAILED (purple) and again suggested to format it. This time format went through with no problem and with the same delay at 98% as it was when I formatted the drives for the very first time. It took about 5 hours to fully synchronize the array. I guess it would be faster if I disabled uPnP media server prior to it.
Hope my experience helps someone.