Your %1 %2 problem.

If you can't find a wininit.ini file then I suspect your problem is due to the
C:\_RESTORE\TEMP folder having around 64K files in it which is the limit
(2**16) for the number of files that can be located in a folder using the
FAT32 filing system.  This then results in the "Cannot upgrade file %1 from
%2.." message when booting.  I suggest you try deleting the _RESTORE folder
with the loss of any system restore checkpoints you might have (not that I
think they are now usable) and see if that solves the problem.  Delete the
folder as follows:
a) Boot to DOS using a floppy.  Do NOT choose "Minimal Boot" from the menu
when booting from a floppy but rather choose "Start computer with (or without)
CD-ROM support" otherwise the ATTRIB command will not be available.
b) At the DOS A:\> prompt, type:

A:\>   ATTRIB    -H   -S    -R    C:\_RESTORE
A:\>   REN    C:\_RESTORE    OLDREST

c) Remove the floppy
d) Reboot your PC

Another problem though is that the update you were doing was never completed
so your system may  be unusable.  If however it does manage to boot then:

e) Delete the folder C:\OLDREST
f) Check that an automatic system restore checkpoint was created.
g) Finally adjust the space allocated to the restore folder:
System | Performance | File System | Hard Disk and adjust the restore slider
to your preferred setting.  A  figure of 200MB is normally more than adequate
for day to day use allowing perhaps a week of checkpoints to be available
although increasing this to perhaps 400MB for a few days during periods of
large installs such Microsoft Office is advisable.