I hardly use sh404sef but decided to with k2. items content works, but when I click on a menu link to a specific category it goes to 404. the url shows xxxx.com/itemlist?layout=category

Go to the K2 parameters window, set something to "sh404SEF URL prefix for categories" (ex: news, archives). It will make your URLs like : www.mydomain.com/news/mycategory/myarticle.html.

Don't forget to clear URL in sh404sef back-end and go to the homepage ;-)