"I`m flattered you asked, but we have several large projects coming in and I`m going to need him dedicated to those"
Even if that`s not the perfect answer, starting with, "I`m flattered you asked, but...." will work.
Nikole,
How did you respond?
R@

Nikole,
Okie dokie. Well, I can`t say it any better than Mark above. Love his response.
R@
PS: It isn`t really stealing ... all`s fair in love and war ... and business. At least they did it to your face - better than most cases I can cite.
I can understand your shock and probably frustration. My situation is a little different than what you are experiencing right now, but it is still very aggravating. It is hard when you have put all your heart and soul into something so close to you and then have someone think they can just waltz in and get in on the action.
I had something like this happen when I first started. Most of my frustration is that I actually played a part in this, I just didn`t see it coming. My "Ex-Friend", was very eager to help and I welcomed the help, we are now competitors. When I first started she was excited and wanted to do something also. It was great as we could share some travel expenses and things. I made some suggestions and helped her come up with some products (not food) but she soon realized where the money was, food. Before I knew it things got out of control and she was dabbling in the same business as I was. Unfortunately, we are no longer friends. Fortunately for me, she only has a few of my mix concoctions, she does not cook and to date has not been able to come up with any additional products so she has remained somewhat stagnant, but, she has copied my logo and everything as far as packaging. She has not been able to attain the level of sales that we have reached, and I really don`t consider her competition anymore, but It Still Sucks
. I learned a valuable lesson the hard way.
I also try not to be bitter about this, it cost a good friend. I can`t blame her for doing this, she saw a good thing and went for it, isn`t that what we all want? What I struggle with the most is that we were friends and she doesn`t seem to have a conscious in regards to what she actually did and that she somehow thinks what she did is ok. 
So be careful from both sides, the competition stealing ideas/employees and also make sure the employee is as faithful as you think and that you have all your bases covered in both these instances. We had been friends since middle school, who`d of thunk it. . .