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I installed CM7 after upgrading to 1.2. You don't need to go to 1.2 first tho. 1.1 and 1.2 will both boot to the SD card first if it's a bootable card.
That said, I installed CM7 over the 1.2 software and love it. It ran noticeably slower from SD card and I was a little disappointed with it. I'm very happy with it now that it's running from the device's memory now.
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