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As I told Meili in a private e-mail, the example work properly with XSLT processors that completely conform to the XSLT Recommendation such as Xalan and Xerces, but Microsoft's processors don't always conform,and this is the kind of problem that can come up.
http://www.vbxml.com/xsl/XSLTRef.asp has a good chart showing where each release of the Microsoft processors are and aren't compliant. I don't know if there's anything about the elements used to control whitespace there.
Bob
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