Check AdminCP > Settings > Options > Image Settings > Image Processing library. What do you have set there? And if you are using ImageMagick, did you enter a binary path that is correct? You can see if either imagemagick or gd are setup correctly by going to:
http://www.yoursite.com/image.php?i=gd // gd is working
http://www.yoursite.com/image.php?i=im // im is working