<xsl:stylesheet version="2.0" xmlns:xsl="http://www.w3.org/1999/XSL/Transform">
<xsl:template match="directories">
<directories>
<xsl:apply-templates select="item[not(contains(path,'.'))]"/>
</directories>
</xsl:template>
<xsl:template match="item">
<directory name="{name}">
<xsl:apply-templates
select="../item[matches(path,concat('^',current()/path,'.[^\.]$'))]"/>
</directory>
</xsl:template>
</xsl:stylesheet>
$ saxon8 table1.xml table1.xsl \!indent=yes
<?xml version="1.0" encoding="UTF-8"?>
<directories>
<directory name="About"/>
<directory name="Services">
<directory name="Environmental"/>
<directory name="Landscaping"/>
</directory>
</directories>
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