High school students talk. If you heard that this guy is making some pathetic attempt at screwing you over and cheating his clients out of the best images for their money (apparently your images), what do you think the kids are saying about this. They probably think this guy is even more of a joke and a flake than they did before. NOT the way to gain support. Parents probably aren't too thrilled about his methods either. If anything, this would give me more reason not to go to him if I was in the market.
Sure, you have a right to be PO'd about his methods, but when it all comes down to it, if he's not having any impact on your business, you don't have anything to worry about. Sucks that this is what he's resorting to, but as you said, you're essentially edging him out of business, whether intentionally or not. Hostile feelings? Well, that was to be expected.
Just keep doing what you're doing, take the high road (as was mentioned above), and sooner or later this guy is going to close up shop and find something else. Sure, sucks to put someone out of business, but that's life. Shame on everyone who thinks that you should bend and fold to accommodate the other guy at your own expense. There's a big difference between being nice/courteous/professional and keeping your business from getting off the ground (or staying afloat).
The business has changed. Gotta change with it, or you become obsolete.