<xsl:output method=”xml” indent=”yes”/>

Saying indent=”yes” in xsl:output allows the processor to indent the output any way it chooses. If you don’t want that, don’t specify indent=”yes”; you will then get no extra whitespace in the output unless you create it explicitly using <xsl:value-of> or <xsl:text>.

If you want more intelligent formatting, you can use Saxon in schema-aware mode, validating the output against a schema. It will then avoid applying indentation to elements that are defined in the schema to have a mixed content model, which seems to be the effect you are looking for here.

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<xsl:variable name=”newline”>
<xsl:text>
</xsl:text>
</xsl:variable>

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http://www.ibm.com/developerworks/xml/library/x-tipwhitesp.html

<xsl:template match=”/”>
<faqoutput><xsl:text>
  </xsl:text><info xml:space=”preserve”>
     <title xml:space=”default”>
       <xsl:value-of select=”faqs/question/questiontitle”/>
     </title>
  </info>
  <xsl:apply-templates/>
</faqoutput>
</xsl:template>

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<xsl:text> </xsl:text>

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Use <xsl:text></xsl:text> to contain literal white space;
you can even do something clever like <xsl:text>
</xsl:text> to send just a newline, or <xsl:text> </xsl:text>
to send five blanks.

And if you use <xsl:if test=…>, you can send your literal
output based on an arbitrary condition.