Drupal 7 image styles ignored by theme preprocess function
By taking over the display of that field you're actually bypassing all the field system would usually do to apply the custom display settings; it basically passes off the responsibility of creating the field HTML to you, and provides you with the raw values you'll need to build it up. 

So if you want to output a style based image, you'll need to do it manually using theme_image_style():

$args = array('style_name' =&gt; 'thumbnail', 'path' =&gt; $item['#item']['uri'], 'alt' =&gt; 'Alt text');
$image = theme('image_style', $args);

// Append $image to your output...