Pretty Print Tidy will not create any sgc classes. Only HTML Tidy will do that. Pretty Print Tidy will format your code to look nice AND it will try to correct common errors in the file in order to make it valid XML code.
If Clean Source is OFF, then you don't need to untick the options below as they are ignored.
To be more specific about the issue with nbsp in the file - the files are missing a DOCTYPE that describes what is in the document. You can add this in manually, or just let Pretty Print Tidy do it for you - which I recommend for most people.
<!DOCTYPE html PUBLIC "-//W3C//DTD XHTML 1.1//EN"
@cybmole - are you sure that if you set Clean Source to OFF and reload the test file that it loads without any warning at all? Since there are several files running around, to be more specific: If I open "Made with 0.6.1 Converted by Calibre.epub" with clean set to OFF, I get warnings. If I set it to Pretty Print Tidy, I don't get warnings. The same with "Sigilnbsp.epub".