I would have to see the whole stylesheet. That new line break in the middle of "line2" is particularly odd, so there could be some culprit outside of your XSLT processor responsible.
I would post the smallest possible complete stylesheet that reproduces the problem, along with a sample source file and the details about what XSLT processor you're using (and for that matter, where the data comes from and where it goes to before you see it, in case there's a chance that some other program is causing the problem) to the XSL-List mentioned below.