A more direct source, from Intel's own CEO (at the time): http://www.theinquirer.net/inquirer/news/2268985/outgoing-in...
Otellini said Intel passed on the opportunity to supply Apple because the economics did not make sense at the time given the forecast product cost and expected volume. He told The Atlantic, "The thing you have to remember is that this was before the iPhone was introduced and no one knew what the iPhone would do... At the end of the day, there was a chip that they were interested in that they wanted to pay a certain price for and not a nickel more and that price was below our forecasted cost. I couldn't see it.
"It wasn't one of these things you can make up on volume. And in hindsight, the forecasted cost was wrong and the volume was 100x what anyone thought."
But the thing I don't understand is why Intel gave up on XScale, their ARM-compatible effort (they held one of the few expensive ARM licenses that allowed them to expand the core architecture). How's Atom doing nowadays? Last I heard, Intel had partnered with Dell to make the Atom-powered Venue android tablets. Can't say they're grabbing headlines with them...