By Karen Freifeld 

NEW YORK, Feb 25 (Reuters) - Macy's Inc Chief Executive Terry Lundgren testified on Monday he was so appalled when Martha Stewart told him in 2011 that she was starting a new alliance with rival J.C. Penney Co Inc that he hung up the phone and has not spoken to her since.

Lundgren, testifying on Monday in the trial of two Macy's lawsuits over the alliance, said Stewart told him of the deal the night before J.C. Penney announced it.

"I was completely shocked and blown away," Lundgren said. "I was literally sick to my stomach."

J.C. Penney said on Dec. 7, 2011, that it would launch Martha Stewart boutiques in about 700 of its department stores in 2013. It also bought 17 percent of her company, Martha Stewart Living Omnimedia.

Macy's, which has its own deal with Martha Stewart, sued her company in January 2012 for breach of contract, and later sued J.C. Penney as well. Macy's says it has the exclusive right to sell Martha Stewart products in certain product categories, including cookware and bedding.

The two cases were consolidated for a non-jury trial before Justice Jeffrey Oing in New York state court in Manhattan.

Lundgren, 60, said Stewart sounded like she was reading from a document prepared by lawyers when they spoke, and that he cut off the conversation when the home goods doyenne, 71, said her deal with J.C. Penney would be good for Macy's.

"I think that's when I hung up," said Lundgren. "The thought this was going to be good for Macy's was so far from anything I could comprehend."

Lundgren said that at the time he considered Stewart a friend, and he has not "responded to her since that phone call on December the sixth. And I don't intend to."

Macy's is still committed to the business relationship it developed with Martha Stewart Living Omnimedia, however. The Martha Stewart brand at Macy's grew 8 percent last year, growth that is twice that of Macy's as a whole, Lundgren said.

"This is an extremely important brand and we are going to continue to highlight the brand in our stores," Lundgren testified.

Macy's built Martha Stewart into its No. 1 home brand after Stewart came out of prison in 2005, having served time for lying about a stock sale.

The Martha Stewart shops in J.C. Penney stores are set to open in May, the centerpiece of an improved home goods section that Chief Executive Ron Johnson has called crucial to returning J.C. Penney to growth.

Lawyers for Martha Stewart Living and J.C. Penney have said the judge should focus on the contract between Macy's and Martha Stewart Living.

Under the contract, Martha Stewart Living Omnimedia can sell product categories exclusive to Macy's if it opens its own stores. Macy's says the proposed boutiques at J.C. Penney are not the same as standalone stores.

Lundgren said that he went with Stewart to Haiti in July of 2011 and sat with her at a $10,000-a-plate fundraiser the following October of 2011 and she never mentioned the impending J.C. Penney announcement.

Lundgren said Stewart told him in their phone conversation she couldn't give prior warning because negotiations with J.C. Penney were confidential, and said she had to take action because her company was in trouble.

Johnson is scheduled to take the stand on Friday. Martha Stewart also is expected to testify, but it is unclear when.

The cases are Macy's Inc. v Martha Stewart Living Omnimedia Inc., 650297/2012, and Macy's Inc. v J.C. Penney Corp., 652861/2012, New York State Supreme Court, New York County.

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