I am reading an xml file from an sftp location and passing that through the
Transformer (using Java1.4.1's API). The xml file has "windows-1252"
encoding declared. It has special characters like ® directly put in the
file.

Any one has any suggestions? I would greatly appreciate!

Just avoid dealing with the encoding yourself and leave it to
the XML parser, for example use plain

byte[] rawData = rawfileOutputStream.toByteArray();
transformer.transform(
  new StreamSource(new ByteArrayInputStream(rawData)),
  new StreamResult(new OutputStreamWriter(out));

If the parser can't handle the windows-1252 encoding and barfs,
get another one.
If you want to check the output you should use UTF-8 as encoding
(the default) and use an UTF-8 capable viewer (Emacs 21 will do
on Solaris).