For recruited athletes, Prep School is the Service Academy equivalent of a Red Shirt Freshman year at a traditional college. You retain your 4 years of eligibility and still have some interaction with the SA coaching staff throughout the year. Each prep school has their own teams, coaches, and facilities - but there is still some interaction with the coach that recruited you.
Historically, the prep school route is reserved for students deemed desirable for the Academy, but need extra instruction to boost their grades to a level that would enable them to be successful under the full Academy experience and work load. Athlete, under represented minority, and prior enlisted tend to make up the vast vast vast majority of the slots. I do not have hard percentages, but having worked at USAFA for one tour and having been a student, I would say it was at 50% or higher for recruited athlete.
In my experience, a 3Q student on the NWL who just did not make the cut for an appointment would not be considered for a Prep School slot.
Students who are not selected for direct admission or prep can still opt to self-prep at their own expense at any of the schools serving the niche field of SA Prep, and then simply re-apply in the next admissions cycle.