No, actually you didn't mention it - just re-read the thread to double-check. And by your screenshots it's not obvious that it's enabled since your code must be using <br/> tags under the hood, otherwise every line in your blockquotes would be indented.
Don't use that feature if you actually want the level of control that you're asking for - everything can be done with a much finer grain of control using extra css. If you enable that feature it over-rides everything else, including extra css.
Here's how to get what you want (with that feature disabled). Put this in extra css before conversion:
Code:
p {margin-top: 0em; margin-bottom: 0.0em; text-indent:1.5em}
blockquote > p {text-indent:0;}