I have created 3 partitions on a 80GB USB HDD
sda1 (Primary Linux) 7Gb
sda2 (Primary w95 FAT32) 72Gb
sda3 (Primary Linux Swap) 1Gb

Formatted partitions
mke2fs -j /dev/sda1
mkdosfs -vF 32 /dev/sda2
mkswap /dev/sda3

Moved iso to USSB Drive
su
cp -av /media/sda2/Users/DL/Kanotix/KANOTIX-2006-Easter-RC4.ISO /media/sda1
sync

Tried creating persistent home dfirectory via Configure-Create a persistent directory but this did not work

Created unionrw.img
cd /media/sda1
dd if=/dev/zero of=unionrw.img bs=1M count=2000
make2fs -j unionrw.img

Made USB drive bootable
cp -av /cdrom/boot /media/sda1/
grub-install --root-directory=/media/sda1 /dev/sda

chmod 644 /media/sda1/boot/grub/menu.lst
mcedit /media/sda1/boot/grub/menu.lst

-- made some changes to grub menu
# my custom config for booting Kanotix from a USB external drive
title Boot Kanotix From USB External Drive
kernel (hd1,0)/boot/vmlinuz ramdisk_size=100000 init=/etc/init lang=us apm=power-off nomce quiet noprompt noeject bootusb2 fromiso=KANOTIX-2006-Easter-RC4.ISO unionrw=/dev/sda1/unionrw.img home=/dev/sda1/knoppix.img
initrd (hd1,0)/boot/miniroot.gz

Everything worked except the persistent home directory stuff. I cannot write to /dev/sda1 for some reason. When I boot enable USB and boot it sits with 'GRUB' in the corner of a black screen. When I boot with live CD and provide options 'bootusb2 fromiso=KANOTIX-2006-Easter-RC4.ISO' (hoping to read the ISO on USB HDD) it says 'Can't find KANOTIX filesystem, sorry Dropping to shell..'

Cannot understand what I am doing wrong also why the persistent home does not work- please help