In book K & R The C Programming Language.
Page No: 88
C provides certain language facilities by means of a preprocessor, which is conceptually a separate first step in compilation.
In book Compiler Principles, Techniques and Tools by Aho, Lam, Sethi and Ullman
Page No. 3
The task of collecting the source program is sometimes entrusted to a separate program, called a preprocessor. The preprocessor may also expand shorthands, called macros, into source language statements. The modified source program is then fed to compiler.
In GCC GNU Documentation
The C preprocessor is a macro processor that is used automatically by the C compiler to transform your program before actual compilation.
Andn read this too.
So from these three official sources, one can say that the Preprocessor is a separate program run by Compiler. So in book Let Us C by Yashwant P Kanetkar that Preprocessor is a program that processes before the compiler as its name suggests is no wrong, and the expanded code can be seen in file.i.
Now let's come to your question,
In book K & R The C Programming Language.
Page No: 89
Substitution are made only for tokens and do not take place within quoted strings.
and as Basile told in his answer that
In current C compilers (for performance reasons) the preprocessor is no longer a separate program, it is part of the compiler itself.
and compiling is a long process that passes through several phases, Preprocessor actually comes after the program is converted in tokens, but as sources says that it is the process of before compilation that means it is done before any kind of intermediate code generation, and yes, breaking program into tokens is the first step of compiler before any intermediate code generation.