By  on March 3, 2013

NEW YORK — Ron Johnson got roughed up Friday.

At times red-faced, flustered and testy, the J.C. Penney Co. Inc. chief executive officer spent nearly four hours tackling probing questions from Macy’s lawyer Theodore Grossman, who tried to paint Johnson as the mastermind behind Martha Stewart’s alleged contract breach with Macy’s Inc.

Clad in a navy suit, white dress shirt and navy-striped tie, Johnson often interrupted the lawyer — and at times Judge Jeffrey Oing — as he sought to add detail to questions proffered by the duo.

Grossman pressured Johnson with a litany of questions ranging from the genesis of his relationship with Stewart to the role Penney’s played in the months leading up to the signing of its contract with Martha Stewart Living Omnimedia Inc. and its taking a 16.6 percent stake in the media company.

When he took the helm in November 2011 (he was appointed in June), Johnson claimed that he “had a mandate to transform” Penney’s, even though it was profitable at the time. Last year, Penney's logged a net loss of $985 million on sales of $12.99 billion. Part of Johnson’s transformation plan would be the creation of shops-in-shop within Penney’s. Johnson said he focused specifically on the home category, and admitted that ever since his days at Target, he marveled at the success of the Stewart brand under Kmart, a partnership the brand had prior to Macy’s.

As a result, Martha Stewart became an “important part” of his plan for Penney’s reinvention, Johnson said, explaining that at the time in 2011, home revenues made up about $250 million to $300 million of the retailer’s overall sales of $17.26 billion.

“I wanted to transform home like others had done before and I wanted to gain that share back that we lost in the 2000s,” he said, saying Martha Stewart’s “influence on home was bigger than any one designer.”

The only problem was that Stewart already had a contract with Macy’s for the department store to sell certain Martha Stewart-branded goods exclusively. The two parties inked that deal in 2007.

RELATED STORY: Macy's Continues to Square Off With Martha, Penney's >>

Johnson said that when he read in the press that Stewart was working with financial advisory firm Blackstone, he realized the company “must not be doing well,” presenting an opportunity for Penney’s.

Over the summer of 2011, prior to his official start at Penney’s, Johnson had meetings with Stewart and Blackstone executives. After his first meeting with Stewart, he wrote to Penney’s board member Steve Roth, according to e-mails quoted in court: “I actually like Martha,” explaining that he’s used to dealing with “people who are difficult because they have a strong point of view. Macy’s deal is key. We need to find a way to break the renewal right in spring 2013.”

When Grossman asked what Johnson meant by the word “break,” Johnson said, “There would have to be an amendment to the Macy’s contract.”

The initial offer for MSLO that Johnson proposed was $7 a share. At the time, MSLO’s stock was trading at $4. The deal also entailed an annual royalty of 2 percent of sales, which would go to “Martha alone,” Johnson said. MSLO would also get one seat on Penney’s board. All this would require that MSLO exit the Macy’s contract.

“Martha can earn $500 million if things go well,” Johnson wrote in an e-mail to his colleagues.

At the time, neither Stewart nor Johnson had approached Macy’s or its ceo Terry J. Lundgren about their potential deal. Johnson testified that he advised Stewart to loop Lundgren in, but she waited until Dec. 6, the night before the deal went public.

That initial offer was scrapped because MSLO didn’t want to sever ties with Macy’s. MSLO had “relatively little to gain” from Penney’s initial offer, Grossman contended.

The looming roadblock to a Penney’s-Stewart agreement was that MSLO did have a contract with Macy’s. Peter J. Solomon, the advisory firm to Penney’s on the deal, suggested the two parties look for a loophole and it found one.

With the help of MSLO’s lawyers, Stewart and MSLO’s then-ceo Lisa Gersh met with Johnson to tell them about the “breakthrough” they identified. In the Macy’s contract, MSLO was allowed to create standalone Martha Stewart stores. This caveat would permit MSLO to open shops-in-shop in Penney’s, Johnson claimed.

“Martha’s lawyers have determined that they can do Martha Stewart Stores, which include ‘stores within a store’….So like Sephora we have a path should Terry not be amenable,” to Stewart exiting her Macy’s contract, the ceo wrote in an e-mail.

A new deal was drafted, which included Penney’s buying a 16.6 percent stake in MSLO for $3.50 a share. Once the agreement was made public on Dec. 7, Johnson wrote an e-mail to William Ackman, Penney’s largest shareholder, telling him “you get a huge assist here.”

Crediting Ackman on his role in the deal, Johnson wrote to him that “without your relationships with Blackstone and your strong connection with Martha,” we “couldn’t have got the deal done.”

“We put Terry in a corner,” Johnson wrote. “Normally when that happens and you get someone on the defensive, they make bad decisions. This is good.”

Grossman pressed for clarity on what “bad decisions” meant, and after some waffling on Johnson’s part, he showed a clip of the ceo’s video deposition in which he admitted a bad decision would be to drop Martha Stewart from its roster.

Johnson’s frustration hit its crescendo when the attorney showed a flurry of e-mails on a projector in the courtroom.

In a well-publicized e-mail to Penney’s then-president Michael Francis, Johnson wrote of the deal with MSLO and its subsequent rollout on Jan. 24: “Terry might have a headache tonight..wait until 1/24 he will have a full on migraine :).”

“Is that a smiley face?” Grossman asked, gesticulating, as reporters and lawyers let out gasps and laughter.

When Johnson mumbled that he couldn’t tell, Grossman magnified the e-mail on the projector.

“Yes,” Johnson replied.

Grossman showed a few more e-mail chains, one of which was from Millard “Mickey” Drexler, ceo of J. Crew Group and a member of the Apple board, congratulating Johnson on the MSLO deal: “Love the move!!!”

Other notes from Johnson included speculation about whether Macy’s would renew its contract with Stewart for five more years, which ultimately, it wound up doing.

The lawyer ended his examination by asking Johnson in regards to his dealings with MSLO and Macy’s: “Would you do it over the same way?”

“Yeah, I believe I would,” Johnson said.

Following the interrogation by the Macy’s lawyer, Penney’s counsel Mark Epstein had his turn.

Almost instantly, Johnson looked more relaxed, smiling at times, as he answered more than an hour of questions on his background and history with Stewart. He professed admiration for the domestic guru and said: “When I met with Martha, it was clear her company was not performing its best. That’s why they retained Blackstone.”

The ceo said Stewart was “frustrated” with Macy’s and that she needed a revenue generator to offset losses in MSLO’s media business. Johnson and Stewart became fast friends as they talked about new possible products they could sell at Penney’s and how she would have the ability to finally have her own store.

Johnson said he wanted to “go forward” even if they couldn’t work around the exclusivity piece of the Macy’s deal.

He added that often, retailers have a “narrow view” when it comes to exclusivity, pointing to the success of Ralph Lauren’s business, which is carried at many different retailers.

“Competition can be your friend,” the ceo said, explaining how his former employer Apple made Best Buy grow.

Johnson’s testimony continues Monday. Martha Stewart is slated to appear in court on Tuesday.

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