UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549   FORM 10-Q    x
QUARTERLY
  REPORT UNDER SECTION 13 OR 15(d) OF THE
  SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended
  March 31, 2006TRANSITION
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For
the transition period from _________ to _________ Commission
file number 1-14762   THE SERVICEMASTER COMPANY
(Exact name of registrant as specified in its charter)    Delaware
36-3858106(State or other jurisdiction
  ofincorporation or organization)
(IRS Employer Identification No.) 3250 Lacey Road, Ste. 600, Downers
Grove, Illinois  §  60515-1700
    (Address of principal executive
offices)                  
   (Zip
Code) 630-663-2000
(Registrants telephone number, including area code) Indicate by
check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days. Yes x     No o Indicate by check mark whether the Registrant is a
large accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of accelerated filer and large accelerated filer in Exchange Act
Rule 12b-2. Large accelerated
  filer x
Accelerated filer o
Non-accelerated filer o Indicate by check mark whether the registrant is a
shell company (as defined in Exchange Act Rule 12b-2). YesoNo x Indicate the number of shares outstanding of each of
the issuers classes of common stock: 290,716,000 shares of common stock on May
2, 2006.    TABLE OF CONTENTS

Page
  No.THE
  SERVICEMASTER COMPANY (Registrant) -Part I. Financial InformationItem 1: Financial Statements
  (Unaudited)Condensed Consolidated
  Statements of Operations for the three
  months ended March 31, 2006 and March 31, 2005

3Condensed Consolidated
  Statements of Financial Position  as
  of March 31, 2006 and December 31, 2005

4Condensed Consolidated
  Statements of Cash Flows for the three months ended March 31, 2006 and March
  31, 2005

5Notes to Condensed
  Consolidated Financial Statements

6Item 2: Management
  Discussion and Analysis of Financial Condition and Results of Operations

16Item
  3: Quantitative and Qualitative Disclosures About Market Risk

26Item 4: Controls and
  Procedures

27Part II. Other
  InformationItem 1A: Risk
Factors

28Item
  2: Unregistered Sales of Equity Securities and Use of Proceeds

28Item
  6: Exhibits

28Signature

292
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANYCondensed Consolidated Statements of Operations (Unaudited)(In thousands, except per share data)

Three Months Ended
  March 31,2006

2005Operating Revenue

$
662,387

$
623,760Operating Costs and Expenses:Cost of services rendered and products sold


434,670


413,871Selling and administrative expenses


195,820


182,363Amortization
  expense


2,085


1,152Restructuring
  charge


3,552


Total operating costs and expenses


636,127


597,386Operating Income


26,260


26,374Non-operating Expense (Income):Interest expense


14,430


15,579Interest and investment income


(10,336
)

(9,374
)Minority interest and other expense, net


2,049


2,046Income from Continuing Operations before Income Taxes


20,117


18,123Provision for income taxes


7,906


7,087Income from Continuing Operations


12,211


11,036Loss
  from businesses held pending sale and discontinued operations, net of income
  taxes


(26,524
)

(464
)Net Income (Loss)

$
(14,313
)
$
10,572Per Share:Basic Earnings
  (Loss) Per Share:Income from continuing operations

$
0.04

$
0.04Loss
  of businesses held pending sale and discontinued operations


(0.09
)

Basic earnings (loss)
  per share

$
(0.05
)
$
0.04Shares


291,549


291,117Diluted Earnings (Loss)
  Per Share:Income from continuing operations

$
0.04

$
0.04Loss
  from businesses held pending sale and discontinued operations


(0.09
)

Diluted earnings (loss)
  per share

$
(0.05
)
$
0.04Shares


296,194


297,080See Notes to Condensed Consolidated Financial
Statements

3

THE
SERVICEMASTER COMPANYCondensed Consolidated Statements of Financial Position
(Unaudited)(In thousands, except per share data)

As of March 31,
  2006

As of December 31,
  2005AssetsCurrent
Assets:Cash and cash
equivalents

$
134,842

$
114,508Marketable
securities


108,086


104,807Receivables,
less allowance of $18,430 and
  $17,702, respectively


361,723


309,567Inventories


68,826


60,331Prepaid
expenses and other assets


72,623


23,948Deferred
customer acquisition costs


69,786


40,402Deferred
taxes


51,976


35,050Assets of
businesses held pending sale and
  discontinued operations


90,376


135,100Total Current
Assets


958,238


823,713Property and
Equipment:At
cost


386,111


364,503Less:
accumulated depreciation


(217,624
)

(202,676
)Net property
and equipment


168,487


161,827Other
Assets:Goodwill


1,589,975


1,548,070Intangible
assets, primarily trade names, net


250,034


230,343Notes
receivable


28,506


30,941Long-term
marketable securities


145,520


147,332Other
assets


10,519


9,304Assets of
businesses held pending sale and discontinued
  operations


75,860


77,340Total
Assets

$
3,227,139

$
3,028,870Liabilities
  and Shareholders EquityCurrent
Liabilities:Accounts
payable

$
106,392

$
91,625Accrued
liabilities:Payroll and
related expenses


79,369


103,028Self-insured
claims and related expenses


81,388


93,047Income taxes
payable


23,454


30,730Other


92,421


87,984Deferred
revenues


491,032


432,741Liabilities of
businesses held pending sale and
  discontinued operations


91,681


97,294Current
portion of long-term debt


19,672


19,222Total Current
Liabilities


985,409


955,671Long-Term
Debt


852,345


638,928Long-Term
Liabilities:Deferred
taxes


120,402


113,300Liabilities of
businesses held pending sale and
  discontinued operations


9,790


10,130Other
long-term obligations


160,635


156,201Total
Long-Term Liabilities


290,827


279,631Minority
Interest


100,000


100,000Commitments
  and ContingenciesShareholders Equity:Common stock
$0.01 par value, authorized
  1,000,000 shares; issued 323,208 and 321,338 shares, respectively


3,232


3,213Additional
paid-in capital


1,124,162


1,117,388Retained
earnings


236,538


282,993Accumulated
other comprehensive income


9,736


7,197Restricted
stock (unearned compensation)





(14,438
)Treasury
stock


(375,110
)

(341,713
)Total
Shareholders Equity


998,558


1,054,640Total
Liabilities and Shareholders Equity

$
3,227,139

$
3,028,870See Notes to
Condensed Consolidated Financial Statements

4

THE SERVICEMASTER COMPANYCondensed Consolidated Statements of Cash Flows
(Unaudited)(In thousands)

Three Months Ended
  March 31,2006

2005Cash and Cash
Equivalents at January 1

$
114,508

$
256,626Cash Flows
from Operating Activities from Continuing
  Operations:Net Income
(Loss)


(14,313
)

10,572Adjustments to
reconcile net income (loss) to
  net cash used for operating activities:Loss from
businesses held pending sale and
  discontinued operations


26,524


464Depreciation
expense


10,650


10,932Amortization
expense


2,085


1,152Change in
working capital, net of acquisitions:Receivables


2,651


(6,949
)Inventories
and other current assets


(83,931
)

(83,471
)Accounts
payable


9,466


16,330Deferred
revenues


53,006


51,834Accrued
liabilities


(44,222
)

(23,486
)Change in tax
accounts:Deferred
income taxes


951


4,391Payment
relating to income tax audits


(4,971
)

(130,568
)Other,
net


4,127


3,238Net Cash Used
for Operating Activities from Continuing
  Operations


(37,977
)

(145,561
)Cash Flows
from Investing Activities from Continuing
  Operations:Property
additions


(11,697
)

(11,210
)Sale of
equipment and other assets


411


393Business
acquisitions, net of cash acquired


(90,548
)

(5,662
)Notes
receivable, financial investments and
  securities


6,611


(10,790
)Net Cash Used
for Investing Activities from Continuing Operations


(95,223
)

(27,269
)Cash Flows
from Financing Activities from Continuing
  Operations:Borrowings of
debt


414,421


125,620Payments of
debt


(203,476
)

(53,338
)Purchase of
ServiceMaster stock


(37,275
)

(15,401
)Shareholders dividends


(32,142
)

(31,980
)Other,
net


16,377


8,652Net Cash
  Provided from Financing Activities from Continuing Operations


157,905


33,553Cash Flows
from Businesses Held Pending Sale and
  Discontinued Operations:Cash used for
operating activities of businesses
  held pending sale and discontinued operations


(4,983
)

(1,739
)Cash provided
from (used for) investing
  activities of businesses held pending sale and discontinued operations


612


(1,074
)Net Cash Used
for Businesses Held Pending Sale and
  Discontinued Operations


(4,371
)

(2,813
)Cash Increase
(Decrease) During the Period


20,334


(142,090
)Cash and Cash
Equivalents at March 31

$
134,842

$
114,536See Notes to
Condensed Consolidated Financial Statements

5

THE
SERVICEMASTER COMPANYNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)

Note 1: The
condensed consolidated financial statements include the accounts of
ServiceMaster and its subsidiaries, collectively referred to as the Company.
Intercompany transactions and balances have been eliminated in consolidation.

Note 2: The
condensed consolidated financial statements have been prepared by the Company
in accordance with accounting principles generally accepted in the United
States (GAAP) and pursuant to the rules and regulations of the Securities and
Exchange Commission. The Company recommends that the quarterly condensed
consolidated financial statements be read in conjunction with the consolidated
financial statements and the notes thereto included in the Companys latest
Annual Report to Shareholders incorporated in the Form 10-K filed with the
Securities and Exchange Commission for the year ended December 31, 2005 (2005
Annual Report). The condensed consolidated financial statements reflect all
adjustments which are, in the opinion of management, necessary for the fair
presentation of the financial position, results of operations and cash flows
for the interim periods. The results of operations for any interim period are
not necessarily indicative of the results which might be achieved for a full
year.

Note
3: The Company
has identified the most important accounting policies with respect to its
financial position and results of operations. These relate primarily to revenue
recognition and the deferral of customer acquisition costs. The following
revenue recognition policies have not changed since year-end. Revenues from
lawn care, pest control, liquid and fumigation termite applications, as well as
heating/air conditioning and plumbing services are recognized as the services
are provided. Revenues from landscaping services are recognized as they are
earned based upon agreed monthly contract arrangements or when services are
performed for non-contractual arrangements. The Company eradicates termites
through the use of baiting systems, as well as through non-baiting methods
(e.g., fumigation or liquid treatments). Termite services using baiting systems
as well as home warranty services frequently are sold through annual contracts
for a one-time, upfront payment. Direct costs of these contracts (service costs
for termite contracts and claim costs for warranty contracts) are expensed as
incurred. The Company recognizes revenue over the life of these contracts in
proportion to the expected direct costs. The Company has franchise agreements
in its TruGreen ChemLawn, Terminix, ServiceMaster Clean, Merry Maids, AmeriSpec
and Furniture Medic businesses. Franchised revenue (which in the aggregate
represents approximately three percent of consolidated revenue) consists
principally of monthly fees based upon the franchisees customer level revenue.
Monthly fee revenue is recognized when the related customer level revenue is
reported by the franchisee and collectibility is assured. Franchise revenue
also includes initial fees resulting from the sale of a franchise. These fees
are fixed and are recognized as revenue when collectibility is assured and all
material services or conditions relating to the sale have been substantially
performed. Due to the seasonality of the TruGreen and Terminix operations,
franchise fee profits comprised 22 percent and 23 percent of the consolidated
operating income before headquarter overhead for the three months ended March
31, 2006 and 2005, respectively, a much higher percentage than is expected for
subsequent quarters and the year as a whole. The portion of total franchise fee
income related to initial fees received from the sale of a franchise was
immaterial to the Companys consolidated financial statements for all periods.

The Company had $491 million and $433 million of
deferred revenue at March 31, 2006 and December 31, 2005, respectively, which
consist primarily of payments received for annual contracts relating to home
warranty, termite baiting, pest control and lawn care services. The revenue
related to these services is recognized over the contractual period as the
direct costs emerge, such as when the services are performed or claims are
incurred.

Customer acquisition costs, which are incremental and
direct costs of obtaining a customer, are deferred and amortized over the life
of the related contract in proportion to revenue recognized. These costs

6

include sales commissions and direct selling costs
which can be shown to have resulted in a successful sale.

TruGreen ChemLawn has significant seasonality in its
business. In the winter and early spring, this business sells a series of lawn
applications to customers which are rendered primarily in March through October
(the production season). This business incurs incremental selling expenses at
the beginning of the year that directly relate to successful sales for which
the revenues are recognized in later quarters. On an interim basis, TruGreen
ChemLawn defers these incremental selling expenses, pre-season advertising costs
and annual repairs and maintenance procedures that are performed in the first
quarter. These costs are deferred and recognized in proportion to the contract
revenue over the production season, and are not deferred beyond the calendar
year-end. Other business segments of the Company also defer, on an interim
basis, advertising costs incurred early in the year. These costs are deferred
and recognized approximately in proportion to revenue over the balance of the
year, and are not deferred beyond the calendar year-end.

The cost of direct-response advertising at Terminix
consisting primarily of direct-mail promotions, is capitalized and amortized
over its expected period of future benefits.

The preparation of the financial statements requires
management to make certain estimates and assumptions required under GAAP which
may differ materially from the actual results. Disclosures in the 2005 Annual
Report presented the significant areas that require the use of managements
estimates and discussed how management formed its judgments. The areas
discussed included the allowance for uncollectible receivables; accruals for
self-insured retention limits related to medical, workers compensation, auto
and general liability insurance claims; accruals for home warranty and termite
damage claims; the possible outcome of outstanding litigation; income tax
liabilities and deferred tax accounts; useful lives for depreciation and
amortization expense; and the valuation of tangible and intangible assets.  There have been no other changes in the
significant areas that require estimates or in the underlying methodologies
used in determining the amounts of these associated estimates.

Note 4: The
Company carries insurance policies on insurable risks at levels which it
believes to be appropriate, including workers compensation, auto and general
liability risks. The Company has self-insured retention limits and insured
layers of excess insurance coverage above those limits. Accruals for
self-insurance losses and warranty claims in the American Home Shield business
are made based on the Companys claims experience and actuarial projections.
Current activity could differ causing a change in estimates. The Company has
certain liabilities with respect to existing or potential claims, lawsuits, and
other proceedings. The Company accrues for these liabilities when it is
probable that future costs will be incurred and such costs can be reasonably
estimated. Any resulting adjustments, which could be material, are
recorded in the period the adjustments are identified.

Note 5:  The
Company has launched Project Accelerate, an internal, multi-phase restructuring
project designed to improve the effectiveness and efficiency of all functional
support areas.  Related to implementing
organizational changes from Project Accelerate, the Company recorded a $3.6
million pre-tax restructuring charge in the first quarter of 2006.  This charge, which is reported in the
Restructuring charge line on the Consolidated Statements of Operations and
was recorded in the Other Operations and Headquarters business segment,
consisted of third-party professional fees and expenses ($2.3 million) directly
related to implementing the organizational changes of Project Accelerate and
employee severance costs ($1.3 million).

Note 6: In accordance with Statement of Financial
Accounting Standards (SFAS) 142, goodwill and intangible assets that are not
amortized are subject to assessment for impairment by applying a fair-value
based test on an annual basis or more frequently if circumstances indicate a
potential impairment. Such

7

circumstances could include
actual earnings being significantly below managements estimates. The Companys
annual assessment date is October 1.

On February
28, 2006, the Company acquired InStar Services Group (InStar) a leading direct
provider of commercial disaster response and reconstruction services. The
results of InStars operations have been included in the Companys
consolidated financial statements since the acquisition date. The acquisition
was for approximately $85 million in cash and included net assets with a fair
value of approximately $40 million, primarily consisting of trade receivables,
project costs in excess of billings and accounts payable and accrued expenses.
The Company recorded $25 million of goodwill, none of which is expected to be
deductible for tax purposes. In addition, the Company recorded $20 million
primarily related to customer relationships, project backlog and other
intangible assets that have a weighted-average useful life of approximately 5
years. In determining this preliminary allocation of purchase price, the Company
utilized the services of third-party valuation experts. Certain preliminary
value allocations are subject to change during the year as final valuation
information is obtained. The remaining increase in goodwill and intangible
assets relates to tuck-in acquisitions completed throughout the first three
months by Terminix and TruGreen ChemLawn.

The table below summarizes the goodwill and intangible
asset activity and balances:

(In thousands)

As of
  December 31,
  2005

Additions

Amortization

As of
  March 31,
  2006Not Amortized:Goodwill

$
1,548,070

$
41,905

$


$
1,589,975Trade names & other


215,493








215,493Amortized:Other intangible assets


49,981


21,776





71,757Accumulated amortization(1)


(35,131
)




(2,085
)

(37,216
)Net other intangibles


14,850


21,776


(2,085
)

34,541Total

$
1,778,413

$
63,681

$
(2,085
)
$
1,840,009(1)
Expected amortization
  expense for 2006 of approximately $10 million is expected to decline by $1.6
  million annually over the next five years.The table below presents, by
segment, the goodwill that is not subject to amortization:

(In thousands)

As of
  March 31,
  2006

As of
  December 31,
  2005TruGreen ChemLawn

$
712,570

$
700,029Terminix


663,766


661,166American Home Shield


85,378


85,526Other Operations &
  Headquarters


128,261


101,349Total

$
1,589,975

$
1,548,070Note 7:
Basic earnings per share are computed by
dividing income available to common stockholders by the weighted-average number
of shares outstanding for the period. The weighted-average common shares for
the diluted earnings per share calculation includes the incremental effect
related to outstanding options and stock appreciation rights (SARS) whose
market price is in excess of the grant price. Shares potentially issuable under
convertible securities have been considered outstanding for purposes of the
diluted earnings per share calculations. In computing diluted earnings per
share, the after-tax interest expense related to convertible securities is
added back to net income in the numerator, while the diluted shares in the
denominator include the shares issuable upon conversion of the securities.  Shares potentially issuable under
convertible securities have not been considered outstanding for the three
months ended March 31,

8

2006 and 2005, respectively, as
their inclusion results in a less dilutive computation.  Had the inclusion of convertible securities
not resulted in a less dilutive computation for the three months ended March
31, 2006 and 2005, incremental shares attributable to the assumed conversion of
the debentures would have increased shares outstanding by 8.0 million shares
for both periods and the after-tax interest expense related to the convertible
debentures that would have been added to net income in the numerator would have
been $1.2 million for both periods.

The following table reconciles both the numerator and
the denominator of the basic earnings per share from continuing operations
computation to the numerator and the denominator of the diluted earnings per
share from continuing operations computation.

(In thousands, except per share data)

Three Months
  Ended March 31, 2006

Three Months
  Ended March 31, 2005Continuing Operations:

Income

Shares

EPS

Income

Shares

EPSBasic earnings per share

$
12,211


291,549

$
0.04

$
11,036


291,117

$
0.04Effect of dilutive securities, net of tax:Options & SARS





4,645








5,963Diluted earnings per share

$
12,211


296,194

$
0.04

$
11,036


297,080

$
0.04Note
8: The Company maintains a shareholder approved incentive plan that allows
for the issuance of equity-based compensation awards, including stock options,
stock appreciation rights, share grants and restricted stock awards. The Company
uses treasury stock and newly issued stock to satisfy equity-based compensation
awards. As of March 31, 2006, there were approximately 32 million Company shares
available for issuance upon the exercise of employee stock options and SARS
outstanding and for future grants. Also, as of March 31, 2006, there was
approximately $34 million of total unrecognized compensation expense related to
non-vested share-based compensation arrangements. That cost is expected to be
recognized primarily over the next four years.

Note
9:  The Companys stock options and stock
appreciation rights, collectively option(s), are issued at a price not less
than the fair market value on the grant date and expire within 10 years of the
grant date.  Certain options may permit
the holder to pay the option exercise price by tendering Company shares that
have been owned by the holder without restriction for an extended period.
Options generally vest over a five year period; however, vesting of certain
awards is accelerated provided the recipient meets certain criteria. For
accelerated awards, the vesting period is shortened within a range of zero to
four years.

In December 2004, the
Financial Accounting Standards Board issued SFAS 123 (revised 2004),
Share-Based Payment (SFAS 123(R)).
SFAS 123(R) replaces SFAS 123, Accounting for Stock-Based Compensation
(SFAS 123), and supersedes Accounting Principles Board Opinion 25, Accounting
for Stock Issued to Employees (APB 25).
SFAS 123(R) requires that stock options and share grants be recorded at
fair value and this value is recognized as compensation expense over the vesting
period.  The Statement requires that
compensation expense be recorded for newly issued awards as well as the
unvested portion of previously issued awards that remain outstanding as of the
adoption of this Statement.  The Company
has adopted the provisions of SFAS 123(R) effective January 1, 2006 using the
modified prospective method which requires application of the rule after
January 1, 2006.

Prior to adopting SFAS
123(R), and beginning in 2003, the Company was using the Prospective Method
as permitted under SFAS 148, Accounting for Stock-Based Compensation 
Transition and Disclosure, an amendment of FASB Statement No. 123, which
required the Company to expense the fair value of new employee option grants
awarded subsequent to 2002.  Related to
the unvested option awards granted prior to 2003, the adoption of SFAS 123(R)
in 2006 resulted in incremental compensation expense in the first quarter of
approximately $1 million pretax, $.6 million after-tax.  For the full year 2006, the Company expects
the total incremental compensation expense related to adopting SFAS 123(R) to
be approximately $3.5 million pretax, or $2.1 million after tax.  Also, effective January 1, 2006, the

9

Company reclassified within
Shareholders Equity the $14.4 million balance of Restricted stock (unearned
compensation) to Additional paid-in capital.

Prior to the adoption of
SFAS 123(R), the Company adjusted option expense related to forfeited options
as the forfeitures occurred.  With the
adoption of SFAS 123(R), the Company is estimating the forfeitures that will
occur and is recording periodic option expense net of the estimated
forfeitures.  The cumulative impact of
the change in accounting for forfeitures was not material to the consolidated
financial statements.

The Company uses a
lattice-based option valuation model to value its option awards.  Under a lattice-based model, expected
volatilities are based on a term structure of implied volatilities from traded
options on the Companys stock and historical volatility of the Companys
stock.  The Company uses historical data
to estimate option exercise and employee termination within the valuation
model.  The expected term of options
granted is derived from the output of the option valuation model and represents
the period of time that options granted are expected to be outstanding.  The range of risk-free rates for periods
within the contractual life of the options is based on the U.S. Treasury
forward curve rate and uses a term structure.
Options granted to employees during the first quarter of 2006 and 2005
had a weighted average fair value of $2.55 and $2.80, respectively.  The following assumptions were used for
options awarded in the first quarter 2006 and 2005:

Three
  Months Ended March 31,2006

2005Expected volatility


17.9% - 42.1
%

27.66% - 47.56
%Weighted-average volatility


19.00
%

28.24
%Expected dividends


3.00
%

3.41
%Expected term (in years)


9


6Risk-free rate


4.39% - 4.64
%

2.98% - 4.65
%Weighted-average risk-free rate


4.54
%

4.06
%Total option expense for the
three months ended March 31, 2006 was approximately $1.6 million, pretax and
the income tax benefits recognized for these awards was approximately $.6
million.

The following table presents the proforma impact on
continuing operations for the three months ended March 31, 2005 of compensation
expense relating to stock option awards as computed under SFAS 123(R):

10

(In thousands, except per share data)

Continuing
  Operations For the
  Three Months Ended
  March 31,  2005Income as reported


$
11,036Add back:  Stock-based
compensation expense included
  in reported net income, net of related tax effects



466Deduct:  Stock-based
compensation expense
  determined under fair-value method, net of related tax effects



(1,606
)Proforma net income


$
9,896Basic Earnings Per Share:As reported


$
0.04Proforma


$
0.03Diluted Earnings Per Share:As reported


$
0.04Proforma


$
0.03A summary of option activity
as of March 31, 2006 and changes during the three months then ended is
presented below:

Shares


Weighted
  Avg.
  Exercise Price

Remaining
  Contractual
  Term

Aggregate
  Intrinsic value
  (millions)Outstanding at December 31,
  2005

29,508,273



$

12.96Granted to
employees

2,126,100



$

12.45Exercised or
vested

(1,785,819
)


$

9.55Terminated or
resigned

(284,504
)


$

16.44Total outstanding, March 31,
  2006

29,564,050



$

13.10



4.3


$

361,067Total exercisable, March 31,
  2006

22,316,241



$

13.42



3.2


$

275,579During the
three months ended March 31, 2006 and 2005, the total intrinsic value of awards
exercised was $6 million and $2 million, respectively. The aggregate intrinsic
value of outstanding and exercisable awards was $361 million and $276 million,
respectively at March 31, 2006 and $381 million and $280 million, respectively
at March 31, 2005. The cash received from the exercise of options totaled $16
million for the three months ended March 31, 2006.

The following table
summarizes the range of exercise prices and the weighted average remaining
contractual life of the options outstanding and the range of exercise prices
for the options exercisable at March 31, 2006:

Range of
  Exercise Prices

Number
  Outstanding
  at 3/31/06

Weighted
  Average
  Remaining
  Contractual
  Term

Weighted
  Average
  Exercise Price

Number
  Exercisable
  at 3/31/06

Weighted
  Average
  Exercise Price$8.40     10.78


9,651,639


5 Years


$
10.13



7,651,579


$
10.09$10.80  15.94


14,155,577


5 Years


$
12.51



8,907,828


$
12.32$16.12  22.33


5,511,608


3 Years


$
18.18



5,511,608


$
18.18$27.20  77.56


245,226


1 Year


$
49.65



245,226


$
49.65$8.40     77.56


29,564,050


4.3 Years


$
13.10



22,316,241


$
13.4211

Note
10:  The Companys share grants and restricted
stock awards have a general vesting period of five years and are restricted as
to the sale or transfer of the shares prior to vesting.  Restricted stock awards are non-transferable
and subject to forfeiture if the holder does not remain continuously employed
by the Company during the vesting period, or, if the restricted stock is
subject to performance measures, if those performance measures are not
attained.  The fair value of the
restricted stock awards is equal to the value of the Companys stock on the date
of grant.  The Company includes the vested
and unvested portions of the restricted stock awards in shares outstanding in
the denominator of its earnings per share calculations.

Restricted stock awards
granted to employees during the three months ended March 31, 2006 and 2005 have
a weighted average fair value of $12.32 and $13.40, respectively.  A summary of the share grant and restricted
stock activity during the three months ended March 31, 2006 is summarized in
the table below:

Shares

Weighted
  Average
  Grant-date
  Fair ValueOutstanding at December 31,
  2005


1,582,877


$

12.09Granted to employees


530,463


$

12.32Exercised or vested


(293,481
)

$

11.81Terminated or
resigned


(2,453
)

$

12.62Total outstanding, March 31,
  2006


1,817,406


$

12.20Total share grant and
restricted stock compensation expense for the three months ended March 31, 2006
was approximately $1.3 million, pre-tax and the income tax benefits realized
for these awards was approximately $.5 million.

Note 11:  In the Condensed Consolidated Statements of
Cash Flows, the caption Cash and Cash Equivalents includes investments in
short-term, highly-liquid securities having a maturity of three months or less.
Supplemental information relating to the Condensed Consolidated Statements of
Cash Flows for the three months ended March 31, 2006 and 2005 is presented in
the following table:

(in thousands
)Cash paid for or (received from):

2006

2005Interest expense

$
24,686

$
22,409Interest and investment income


(8,919
)

(7,402
)Income taxes, net of refunds


11,999


132,947The increase in cash
received from interest and investment income reflects a higher level of
investment income and gains realized on the growing investment portfolio at
American Home Shield. Cash paid for income taxes decreased in 2006 as a result
of $131 million of taxes paid last year to the IRS and various states pursuant
to the Companys agreement with the Internal Revenue Service (IRS) that
was reached in January 2005.

Note 12: Total
comprehensive income (loss) was ($12) million and $9 million for the three
months ended March 31, 2006 and 2005, respectively. Total comprehensive income
primarily includes net income (loss), changes in unrealized gains and losses on
marketable securities and foreign currency translation balances.

Note 13: The
Company has an agreement to provide for the ongoing revolving sale of a
designated pool of accounts receivable of TruGreen ChemLawn and Terminix to a
wholly owned, bankruptcy-remote subsidiary, ServiceMaster Funding LLC.
ServiceMaster Funding LLC has entered into an agreement to transfer, on a
revolving basis, an undivided percentage ownership interest in a pool of
accounts receivable to unrelated third party purchasers. ServiceMaster Funding
LLC retains an undivided percentage interest in the pool of accounts receivable
and bad debt losses for the entire pool are allocated first to this retained
interest. During the three months ended March 31, 2006 and 2005, there were no

12

receivables sold to third parties under this
agreement. However, the Company may sell its receivables in the future, which
would provide an alternative funding source. The agreement is a 364-day
facility that is renewable at the option of the purchasers. The Company may
sell up to $70 million of its receivables to these purchasers and therefore has
immediate access to cash proceeds from these sales. The amount of the eligible
receivables varies during the year based on seasonality of the business and
will, at times, limit the amount available to the Company.

Note 14: Total
debt was $872 million at March 31, 2006, approximately $214 million
above the level at December 31, 2005. The increase in debt reflects the
acquisition of InStar and normal seasonal working capital requirements.  Approximately 66 percent of the Companys
debt matures beyond five years and 56 percent beyond fifteen years. The
Companys next significant debt maturity is not until 2007.

Note 15: As
disclosed in the 2005 Annual report, the Company intends to sell its American
Residential Services (ARS) and American Mechanical Services (AMS) operations.
The ARS/AMS operations provide heating, ventilation, air conditioning (HVAC),
plumbing and electrical installation and repair. Because the Company intends to
sell these companies, the results of these operations are reported within the
financial statement caption businesses held pending sale and discontinued
operations for all periods. In the first quarter of 2006, the Company
recorded a $25 million after tax provision for expected losses on the
disposition of certain ARS/AMS properties. Under generally accepted accounting
principles, an estimated impairment loss must be recognized when deemed
probable, while potential gains must be deferred until the sales actually
close.


The results
of businesses held pending sale and discontinued operations for the three months
ended March 31, 2006 and 2005 are as follows:

(In thousands, except per share data)
     2006
     
     2005Revenue
     
     
     $178,198
        
     $158,549ARS/AMS operating loss
     $(509
        )
     $(524
        )Impairment charge (pretax)
     (42,000
        )
     Other discontinued operations
     (2,063
        )
     (239
        )Pretax loss
     (44,572
        )
     (763
        )Income tax benefit
     18,048
        
     299Loss from businesses held pending saleand discontinued operations
     $(26,524
        )
     $(464
        )Per diluted share loss from businesses heldpending sale and discontinued operations
     $(.09
        )
     The following table summarizes the activity during the
three months ended March 31, 2006 for the remaining liabilities from previously
discontinued operations and does not include the liabilities of businesses held
pending sale (ARS/AMS).

(In thousands)

Balance at
  December 31,
  2005

Cash
  Payments
  or Other

Income/
  (Expense)

Balance at
  March 31,
  2006Remaining
  liabilities from discontinued operations

$
16,036

$
753

$
(1,813
)
$
17,096Note
16: In the ordinary course, the Company is subject to review by
domestic and foreign taxing authorities, including the IRS. As previously
disclosed, the U.S. federal tax returns filed by the Company through the 2004
return have already been reviewed by the IRS. The Company paid $5 million in the
first quarter of 2006 relating to the resolution of the 2003 and 2004 audits. In
the first quarter of 2005, the IRS commenced the audit of the Companys tax
return for 2005 and, in the first quarter of 2006, the IRS commenced the audit
of the Companys tax return for 2006. As with any review of this nature,
the outcomes of the IRS examinations are not known at this time.

Note 17:
The business of the Company is conducted through five operating
segments: TruGreen ChemLawn, TruGreen LandCare, Terminix, American Home
Shield and Other Operations and Headquarters. The TruGreen ChemLawn segment
provides residential and commercial lawn care services. The TruGreen LandCare
segment provides landscape maintenance services primarily to commercial
customers. The Terminix segment provides termite and pest control services to
residential and commercial customers. The American Home Shield segment provides
home warranties to consumers that cover heating, ventilation and air
conditioning (HVAC), plumbing and other home systems and appliances. This
segment also includes home inspection services provided by AmeriSpec. The Other
Operations and Headquarters segment includes InStar Services Group, a direct
provider of commercial disaster response and reconstruction services as well as
the franchised and Company-owned operations of ServiceMaster Clean, Furniture
Medic and Merry Maids, which provide disaster restoration, commercial cleaning,
carpet and upholstery cleaning, furniture repair and maid services. The
Other

13

Operations and Headquarters segment also includes the
Companys headquarters operations, which provide various technology, marketing,
finance, legal and other support services to the business units. Segment information is presented in the following
table.



(In thousands)

Three Months
  Ended March 31,
  2006

Three Months 
  Ended March 31,
  2005Operating Revenue:TruGreen ChemLawn

$
137,264

$
123,336TruGreen LandCare


98,921


99,646Terminix


253,539


247,745American Home Shield


116,930


111,010Other Operations &
  Headquarters


55,733


42,023Total Operating Revenue

$
662,387

$
623,760Operating Income (Loss): (1)TruGreen ChemLawn

$
(2,823
)
$
(7,307
)TruGreen LandCare


(1,818
)

(301
)Terminix


33,462


30,765American Home Shield


9,133


14,273Other Operations &
Headquarters


(11,694
)

(11,056
)Total Operating Income

$
26,260

$
26,374(1)
Presented
  below is a reconciliation of segment operating income to income from
  continuing operations before income taxes.(In thousands)

Three Months
  Ended March 31,
  2006

Three Months
  Ended March 31,
  2005Segment Operating Income

$
26,260

$
26,374Non-operating expense
  (income):Interest expense


14,430


15,579Interest and investment
income


(10,336
)

(9,374
)Minority interest and other
expense, net


2,049


2,046Income from Continuing
  Operations before Income Taxes

$
20,117

$
18,123The combined operations of
ServiceMaster Clean and Merry Maids, which are included in the Other Operations
and Headquarters segment, comprised approximately six percent of the
consolidated revenue for the three months ended March 31, 2006 and 2005.  These operations comprised
approximately  23 percent and 24 percent
of the consolidated operating income before headquarter overheads for the three
months ended March 31, 2006 and 2005, respectively, a much higher percentage than
is expected for subsequent quarters and the year as a whole.

(In thousands)

As of
  March 31, 2006

As of
  December 31, 2005Identifiable Assets:TruGreen ChemLawn

$
1,014,020

$
885,153TruGreen LandCare


92,962


92,694Terminix


874,015


862,270American Home Shield


532,675


530,486Other Operations &
Headquarters


713,467


658,267Total Identifiable Assets

$
3,227,139

$
3,028,87014

(In thousands)

As of
  March 31, 2006

As of
  March 31, 2005Capital Employed: (2)TruGreen ChemLawn

$
852,624

$
823,129TruGreen LandCare


37,507


39,444Terminix


653,884


626,962American Home Shield


217,065


167,813American
Home Shield without Cash and marketable securities (2)


(69,858
)

(81,513
)Other Operations &
  Headquarters


209,495


286,949Total Capital Employed

$
1,970,575

$
1,944,297(2)
Capital employed is a
  non-U.S. GAAP measure that is defined as the segments total assets less
  liabilities, exclusive of debt balances. The Company believes this
  information is useful to investors in helping them compute return on capital
  measures and therefore better understand the performance of the Companys business
  segments. The calculation of capital employed for the American Home Shield
  segment includes approximately $287 million and $249 million of cash and
  marketable securities at March 31, 2006 and 2005, respectively.  The investment income and realized gains/losses
  on these assets are reported below operating income in non-operating
  income/expense.  In order to
  facilitate the comparison of return on invested capital for the American Home
  Shield segment, the Company has also presented capital employed for this
  segment excluding cash and marketable securities.  The negative capital employed balances primarily result from
  deferred revenue and amounts payable to subcontractors.  Presented below is a reconciliation of
  total segment capital employed to the most comparable U.S. GAAP measure.(In thousands)

As of
  Mar. 31, 2006

As of
  Mar. 31, 2005Total Assets

$
3,227,139

$
3,097,459Less:Current liabilities, excluding
current portion of long-term debt


965,737


906,092Long-term liabilities


290,827


247,070Total Capital Employed

$
1,970,575

$
1,944,29715

MANAGEMENT DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

FIRST QUARTER 2006
COMPARED TO 2005

ServiceMaster
(the Company) reported first quarter 2006 revenue of $662 million, a six
percent increase compared to 2005, which includes two percent growth from the first
time impact of InStar Services Group (InStar), which was acquired at the end of
February. Diluted earnings per share were a loss of ($.05) compared to income
$.04 in 2005. In the first quarter of 2006, the Company recorded a non-cash
charge of $25 million after-tax ($.08 per diluted share) for expected losses on
the disposition of certain ARS/AMS properties held pending sale. This charge is
included in the loss from businesses held pending sale and discontinued
operations.

Diluted
earnings per share from continuing operations were $.04, consistent with 2005.
Operating income for the first quarter was $26 million, comparable to the prior
year. The 2006 results included a $3.6 million pre-tax charge for severance and
other restructuring costs associated with the Companys Project Accelerate
initiative. Operating income was favorably impacted by higher profits at
TruGreen ChemLawn supported by increased revenue from an earlier start to
production, solid growth at Terminix reflecting lower production and sales
labor costs and improving termite damage claim experience as well as continued
favorable trending of prior year insurance claims. These factors were more than
offset by the restructuring charge, lower profits at American Home Shield
resulting from timing differences in certain selling costs and planned
investments to increase market penetration and customer retention, reduced snow
removal at TruGreen LandCare and increased fuel and benefits costs throughout
the enterprise.

The
Company continues to experience both positive and negative trending in some of
its key factor costs. The Companys large fleet, which consumes roughly 30
million gallons of fuel annually, continues to be negatively impacted by significant
increases in oil prices. The Company hedges approximately two-thirds of its
estimated annual fuel usage at the end of the preceding calendar year, but this
years hedge prices are meaningfully higher than last year, and prices have
continued to increase. Entering the year, the Company had estimated that its
continuing operations would absorb approximately $.02 per share of incremental
fuel costs for the full year 2006. If fuel prices remain at current prices for
the balance of the year, the Company could incur additional fuel costs of up to
$.01 per share in excess of the original estimate. As previously discussed, the
Company has been implementing GPS and routing and scheduling technologies that
will tighten routes and reduce drive time and fuel consumption.

Health
care costs continue to experience strong inflationary pressures, and this is
expected to continue. As previously disclosed, the Company is making an
additional investment in employee health care benefits in 2006 as part of its
efforts to further enhance its position as an employer of choice. For the first
quarter of 2006, the Company experienced a $.01 per share increase in
healthcare and related costs, with an incremental impact of $.03 per share
expected for the year as a whole.

On
the positive side, the Company continues to experience favorable results from
its efforts to reduce safety-related costs, which include workers compensation,
auto and general liability claims. In the first quarter of 2006 total
safety-related costs from continuing operations, including the income statement
effects of favorable trending of prior year claims, decreased approximately
$.01 per share. Consistent with the Companys plan, we anticipate additional
reductions over the balance of the year, but due to very strong performance
last year, at well below the pace that was experienced in the first quarter.

16

The Company has launched
Project Accelerate, an internal, multi-phase restructuring project designed to
accomplish four objectives: realign the Companys cost structure in light of
divestitures, create a more effective and efficient functional support
structure, provide funds for reinvestment in growth initiatives, and provide
tangible savings to the bottom line. The design phase of the project was
completed at the end of the first quarter, with implementation staged mostly
over the balance of this year. The Companys current estimate is for ultimate
pre-tax savings, net of reinvestments in the $25 million to $35 million range,
or $.05 to $.07 per share, to be fully realized in 2008. The Company expects to
get there progressively with approximately $.02 per share of net savings in
2006, mostly in the second half of the year, $.04 to $.05 in 2007, and the
balance in 2008. Most of these savings will benefit the selling, general and
administrative line in the income statement, although some savings, such as
those from safety and sourcing initiatives, will benefit cost of sales.

Related to implementing
organizational changes from Project Accelerate, the Company recorded a $3.6
million pre-tax restructuring charge in the first quarter of 2006. This charge
is reported in the Restructuring charge line on the Consolidated Statements
of Operations and was recorded in the Other Operations and Headquarters
business segment. The Company expects that all restructuring charges will be
incurred and recognized prior to year end, and is confident that the total
restructuring charge will not exceed $8 million to $9 million. The Company
expects to pay the majority of the restructuring costs by the end of 2006.

Cost of
services rendered and products sold increased five percent for the first
quarter and decreased as a percentage of revenue to 65.6 percent in 2006 from
66.4 percent in 2005, primarily reflecting accelerated production at TruGreen
ChemLawn and favorable trending of prior year insurance claims. Selling and
administrative expenses increased seven percent for the quarter. As a
percentage of revenue, these costs increased to 29.6 percent in 2006 from 29.2
percent in 2005, primarily reflecting the timing of certain selling costs and
incremental investments in initiatives intended to increase market penetration
and improve customer retention at American Home Shield, an increase in
incentive compensation related to an employee deferred compensation trust that
is more fully discussed below, as well as $1 million of incremental stock
option expense resulting from the Companys adoption of Statement of Financial
Accounting Standards (SFAS) 123(R).

Net
non-operating expenses were reduced by approximately $2 million in the first
quarter, reflecting lower interest expense resulting from lower average debt
balances and higher interest income experienced on the American Home Shield
investment portfolio. The 2006 balance includes a $1.7 million increase in
investment income in an employee deferred compensation trust for which there is
a corresponding and offsetting increase in compensation expense within
operating income (as noted above). The 2005 amount included a $2.5 million
increase in interest income resulting from the correction in the accounting for
a specific investment at American Home Shield.

Outlook

For 2006, the
Company expects earnings per share before restructuring charges to increase at
low double digit rates, with most of the earnings growth occurring in the second
half of the year. Specific timing items and the relative growth of factor costs
will work against the Company in the second quarter, but help it in the second
half of the year. More importantly, expanded direct marketing initiatives in
major business units, expected improvements in customer retention and price
realization trends, and the positive effects of Project Accelerate and the
InStar acquisition will have a proportionally greater impact in the second half
of the year, which includes our peak production period. These are also expected
to provide the foundation for stronger growth in future years.

17

Key Performance Indicators

The table
below presents selected metrics related to customer counts and customer
retention for the three largest profit businesses in the Company. These
measures are presented on a rolling, twelve-month basis in order to avoid
seasonal anomalies.

Key
  Performance Indicators
  As of March 31,2006
  
  2005TruGreen ChemLawn-Growth in
Full Program
  Contracts
  
  
  -4
  %
  
  6
  %Customer
Retention Rate
  
  
  63.0
  %
  
  65.5
  %Terminix -Growth in
Pest Control
  Customers
  
  
  3
  %
  
  6
  %Pest
Control Customer Retention
  Rate
  
  
  76.9
  %
  
  77.2
  %Growth in
Termite Customers
  
  
  0
  %
  
  0
  %Termite
Customer Retention Rate
  
  
  87.2
  %
  
  87.8
  %American Home Shield -Growth in
Warranty Contracts
  
  
  4
  %
  
  5
  %Customer
Retention Rate
  
  
  57.7
  %
  
  55.7
  %Segment Reviews for the First Quarter 2006 Compared to
2005

The following business segment reviews should
be read in conjunction with the required footnote disclosures presented in the
Notes to the Condensed Consolidated Financial Statements. This disclosure
provides a reconciliation of segment operating income to income from continuing
operations before income taxes, with net non-operating expenses as the only
reconciling item. The Companys business segment reviews include discussions of
capital employed, which is a
non-U.S. GAAP measure that is defined as the segments total assets less liabilities, exclusive of debt balances. The
Company believes this information is useful to investors in helping them
compute return on capital measures and therefore better understand the
performance of the Companys business segments. The Notes to the Condensed Consolidated Financial Statements also include a
reconciliation of segment capital employed to its most comparable U.S. GAAP
measure.

The TruGreen
ChemLawn segment, which provides lawn care services to residential and
commercial customers, reported an 11 percent increase in revenue to $137 million
compared to $123 million in 2005. The segment reported a seasonal first quarter
operating loss of ($3) million compared to an operating loss of ($7) million in
2005. Revenue growth included the favorable effects of an earlier spring, which
resulted in increased lawn applications and the acceleration of approximately $7
million of revenue. Operating results for the quarter improved by approximately
$4 million, resulting from increased revenues, offset in part by increases in
fuel and health benefit costs. The Company realized a two percent improvement in
average prices during the quarter, and is currently trending toward a three
percent increase for the year as a whole, an improvement over recent historical
averages. The interim decline in customer counts was primarily attributable to a
continued shift away from telemarketing sales, which have historically been
heavily concentrated in the first quarter. Due to the continued expansion of Do
Not Call lists, telemarketing sales in the first quarter fell 20 percent below
prior year levels. However, the Company continues to expand alternative sales
channels, particularly direct mail and neighborhood selling, which increased
nine percent but fell short of the Companys planned levels. Sales from
these channels, which tend to produce a more loyal customer than telemarketing
sales, are more heavily

18

concentrated in the second quarter than the first quarter. The Company
believes that the first quarter decline in retention rates is temporary in
nature, and will swing to a net improvement by the end of the year. The decline
was impacted, in part, by the earlier start to production, since the Company
historically experiences an increase in cancellations following the first round
of program applications. Since the Companys retention is computed on a rolling
twelve month basis, the March 31st comparison also reflects
increased cancellations in the second half of last year as a result of drought
conditions in several key markets. Management has a strong focus on improving
retention. New or expanded efforts include performing lawn quality audits on
all first year customers, implementing faster response standards on service
calls, and improving customer communication and problem resolution procedures.
The Company expects these changes to lead to improved retention for the year as
a whole, and is encouraged by more recent results.

Capital
employed in the TruGreen ChemLawn segment increased four percent, primarily
reflecting the impact of tuck-in acquisitions.

The TruGreen
LandCare segment, which provides landscape maintenance services primarily to
commercial customers, reported a one percent decrease in revenue to $99 million
compared to $100 million in 2005, and an operating loss of ($1.8) million
compared to ($.3) million in 2005. Base contract maintenance revenue increased
modestly in the first quarter. The Company has experienced improvements in
customer retention and is anticipating further increases for the balance of the
year, resulting from improved procedures related to customer communications,
problem resolution and landscape inspections, as well as the positive effects
of more selective targeting of sales prospects. The Company is also taking
steps to increase maintenance sales by expanding the size and caliber of its
sales force and providing them with better tools and training. Enhancement
revenue (e.g., add-on services such as seasonal flower plantings, mulching,
etc.), which accounts for approximately one-third of TruGreen LandCares annual
revenues, increased at a strong double-digit rate, reflecting intensified
management focus and strong sales in the Companys year-round markets. The
Companys snow removal business, which is very profitable, accounts for only about
five percent of full year revenue but a larger percentage of first quarter
totals. In the first quarter, snow removal revenue decreased $7 million,
causing overall revenue to be comparable to last year. Operating results for
the quarter were impacted by the lower level of high margin snow removal
revenue as well as increased fuel costs. Operating income from snow removal
decreased approximately $4 million.

Capital
employed in the TruGreen LandCare segment decreased five percent, primarily
reflecting improved fixed asset and equipment utilization.

The Terminix
segment, which includes termite and pest control services, reported a two
percent increase in first quarter revenue to $254 million, compared to $248
million in 2005. Operating income increased nine percent to $33 million compared
to $31 million in 2005. Terminixs overall revenue growth for the quarter
was impacted by offsetting results on the termite side of the business. A solid
increase in termite renewal revenues resulted from improved pricing and
stabilizing customer retention. Revenue from initial termite applications
(termite completions) decreased in the first quarter. A three
percent increase in unit sales was achieved despite a weak start to the annual
termite swarm season in most parts of the country that continued throughout
April. The Company believes the weak swarm is an industry-wide phenomenon, and
that the Company has maintained or improved its market share. The Company also
experienced an additional shift in mix from bait to lower priced liquid
applications. The mix shifted from approximately 70 percent liquid/30 percent
bait late last year to approximately 80 percent liquid/20 percent bait this
quarter. The Companys customer research suggests that the mix should begin
to stabilize around these levels. An important factor to note is that while the
Company realizes less revenue and profit from a liquid job in the first year,
the average lifetime profitability of a liquid and bait customer are fairly
closely aligned. First quarter pest control revenue increased approximately
three percent, supported by good commercial growth and the impact of
acquisitions. Terminix achieved very solid profit growth despite higher fuel and
benefit costs. This occurred as a result of lower sales costs and improving
damage claim experience from the use of a more effective liquid

19

termiticide.
Termite production labor also improved due to the new perimeter treatment
technique, which is quicker and less intrusive than other methods. This
technique was rolled out over the first half of 2005. In the first quarter of
2006, Terminix recorded a $2 million provision for costs associated with site
remediation at two locations. In the first quarter of 2005, Terminix recorded
$3 million of incremental damage claim expense due to a correction in
estimating prior years termite damage claims reserves.

Capital
employed in the Terminix segment increased four percent, reflecting the impact
of tuck-in acquisitions.

The American
Home Shield segment, which provides home warranties to consumers that cover
heating, ventilation and air conditioning (HVAC), plumbing and other home
systems and appliances, reported a five percent increase in revenue to $117
million from $111 million in 2005 and a decrease in operating income to $9
million from $14 million in 2005. New warranty contract sales, which are
reported as earned revenue over the subsequent twelve-month contract period,
increased one percent for the quarter, with much stronger growth anticipated in
subsequent quarters. A solid increase in customer renewals, which are American
Home Shields largest source of revenue, was supported by a larger base of
renewable customers and a 200 basis point improvement in customer retention.
The improvement in retention reflects a more favorable mix of renewing
customers and a significant improvement in problem resolution ratings from our
customers. The Company is targeting further retention improvements, and
continues to invest in various service and customer satisfaction initiatives
toward that end. American Home Shields second largest channel, real estate
sales, declined one percent as home listings and closings were impacted by a
weakening home resale market, which was particularly acute in California and a
few other states where the Company has a major presence. Longer term, the
Company believes this channel provides a significant opportunity to expand its
geographic presence and increase what is still a relatively low, industry-wide
household penetration rate. As such, the Company continues to invest in an
expanded real estate sales force (up 20 percent from prior year levels) and
related marketing support, particularly in locations that are currently under
penetrated. The Company has also added staff to more aggressively pursue
opportunities with major, multi-office accounts. Sales in the direct to
consumer channel declined in the quarter, strictly due to the timing of certain
direct mail campaigns. As perspective on the timing issue, the Company mailed
approximately three and one-half times as many pieces in the first quarter of
this year as in the fourth quarter of last year, which was relatively light.
This years mailings were also substantially higher than those made in the
first quarter last year. Mailing costs are recognized as incurred, not when the
related sales actually close, and this timing difference had a very significant
impact on first quarter operating income and margin comparisons. The decrease
in operating income reflects the timing of sales costs and incremental planned
investments in sales and customer retention initiatives. More favorable
operating income comparisons are anticipated for the year as a whole. Capital
employed increased 29 percent primarily reflecting a higher level of cash and
marketable securities due to the growth in the business and improved market
performance. Capital employed at American Home Shield, which totaled $217
million and $168 million at March 31, 2006 and March 31, 2005, respectively,
includes $287 million and $249 million of cash, short-term and long-term
securities at those dates. The investment income and realized gains/losses on
these assets are reported as non-operating income/expense.

The Other
Operations and Headquarters segment includes the operations of ServiceMaster
Clean, InStar and Merry Maids as well as the Companys headquarters functions.
Revenue in this segment increased to $56 million from $42 million in 2005
reflecting one month of revenue from the acquisition of InStar Services Group,
Inc. (InStar) and solid growth in the franchise operations of ServiceMaster
Clean and Merry Maids. On a combined-basis, the franchise operations reported
revenue growth of seven percent, primarily reflecting strong internal revenue
growth as well as acquisitions at Merry Maids.

In February
2006, the Company completed the acquisition of InStar, a leading direct
provider of commercial disaster response and reconstruction services in the
United States. InStar provides a continuum of services, from planning prior to
an event, to emergency response following the event and ultimately including
cleaning, recovery and reconstruction. The Company believes there is a great

20

strategic fit
in combining the capabilities of InStar with the Companys existing disaster
restoration business within ServiceMaster Clean. ServiceMaster Cleans disaster
restoration business already totals over $500 million in customer level revenue
through its franchisee network and has been growing at double digit rates for
more than five years. The Company expects the InStar acquisition, after
interest and amortization costs, to be accretive in the $.01 per share range
for the period in 2006 following the acquisition.

The Other
Operations and Headquarters segment operating loss for the quarter was ($12)
million compared with ($11) million in 2005. Included in the first quarter 2006
operating loss are restructuring costs of $3.6 million associated with Project
Accelerate. The segment operating loss, which included the aforementioned
restructuring charge, was comparable to 2005, reflecting favorable trending of
prior year insurance claims, the first time inclusion of operating profits from
InStar as well as increased profits from the combined franchise businesses,
offset in part by the previously discussed compensation expense related to an
employee deferred compensation trust and incremental stock option expense
resulting from the Companys adoption of SFAS 123(R). Capital employed in this
segment decreased, primarily reflecting the realization of the annual tax
benefit associated with the amortization of tax intangible assets that will
continue through 2012.

FINANCIAL POSITION
AND LIQUIDITY

Cash Flows from
Operating Activities

Net cash used for operating
activities from continuing operations in the quarter was $38 million, compared
to $146 million used for operating activities in the prior year. The decrease
in cash used for operating activities from continuing operations primarily
reflects the prior year $131 million tax payments relating to the 2005 IRS
agreement. In February 2006, the IRS concluded the 2003 and 2004 audits of the
Companys tax returns and during the three months ended March 31, 2006, the
Company paid $5 million of taxes and interest to the IRS and various states.
Excluding the impact of these two tax items, three month cash used for
operating activities from continuing operations increased $18 million,
primarily due to higher working capital requirements.

Historically,
the first quarter is a period of investment for many of the Companys businesses
as they prepare for the summer and fall production season. Even after excluding
the impact of the IRS agreements, the Company expects full year cash provided
from operating activities to again substantially exceed net
income. This expected result reflects a solid earnings base, businesses that
need relatively little working capital to fund growth in their operations, and
significant annual recoveries of tax assets.

The
significant annual cash tax benefit that results from the recovery of tax
assets primarily is associated with a large base of amortizable intangible
assets which exist for income tax reporting purposes, but not for book
purposes. A significant portion of these assets arose in connection with the
Companys 1997 conversion from a limited partnership to a corporation. The
amortization of the tax basis will result in approximately $57 million of
average annual cash tax benefits through 2012 for which no corresponding income
statement benefit is recorded. The Company estimates that the divestitures of
ARS and AMS will result in a reduction of approximately $4 million in the
average annual cash tax benefits; however, the cash tax benefits in the period
of divestiture will increase such that the aggregate tax benefits are
unchanged.

In
the ordinary course, the Company is subject to review by domestic and foreign
taxing authorities, including the IRS. In the first quarter of 2005, the IRS
commenced the audit of the Companys 2005 tax return, and in the first quarter
of 2006, the IRS commenced the audit of the Companys 2006 tax return. As with
any review of this nature, the outcomes of the IRS examinations are not known
at this time.

21

Cash Flows from
Investing Activities

Capital expenditures were
consistent with prior year and included recurring capital needs and information
technology projects. The Company anticipates approximately $50 million of
capital expenditures in 2006, reflecting investments in information systems and
productivity enhancing operating systems. The Company has no material capital
commitments at this time.

Acquisitions for the three
months ended March 31, 2006 totaled $104 million, compared with $8 million in
2005. This increase reflects the acquisition of InStar, a leading direct
provider of commercial disaster response and reconstruction services, for
approximately $85 million of cash. Consideration paid for tuck-in acquisitions
in lawn care and pest control consisted of cash payments, seller financed notes
and Company stock. The Company expects to continue its tuck-in acquisition
program at both Terminix and TruGreen ChemLawn.

Cash Flows from
Financing Activities

Cash dividends paid to
shareholders totaled $32 million or $.11 per share for the three months ended
March 31, 2006. In May 2006, the Company announced the declaration of a cash
dividend of $.11 per share payable on May 31, 2006 to shareholders of record on
May 15, 2006. The timing and amount of future dividend increases are at
the discretion of the Board of Directors and will depend, among other things,
on the Companys capital structure objectives and cash requirements.

In February
2006, the Board of Directors authorized $250 million for share repurchases.
This authorization replaces the unused portion ($30 million at December 31,
2005) from the previous authorization granted in July 2000. The Company
completed approximately $44 million in share repurchases in the first three
months of 2006 at an average price of $12.72 per share. There remains
approximately $206 million available for repurchases under the February 2006
authorization. The Company expects share repurchases for the full year to be at
the high end of its previously stated range of $80 million to $100 million.
Based on the strength of both the Companys existing cash flows and its future
growth expectations, the Company is reviewing with its Board the potential
merits of increasing its total annual cash returns to shareholders, through an
increased dividend growth rate and/or heightened share repurchases. There are
no assurances that any changes will be made and the Company currently expects
to reach a decision by late July. The actual level of future share repurchases
will depend on various factors, such as the Companys commitment to maintain an
investment grade credit rating and other strategic investment opportunities.

Liquidity

Cash and short
and long-term marketable securities totaled approximately $388 million at March
31, 2006, compared with $367 million at December 31, 2005. Approximately $361
million of the 2006 amount is effectively required to support regulatory
requirements at American Home Shield and for other purposes. Total debt was
$872 million at March 31, 2006, approximately $214 million more than the amount
at December 31, 2005. This increase reflects funding for normal seasonal
working capital needs and the first quarter acquisition of InStar for
approximately $85 million.

Approximately
66 percent of the Companys debt matures beyond five years and 56 percent
beyond fifteen years. The Companys next significant debt maturity is not until
2007.

Management
believes that funds generated from operating activities and other existing
resources will continue to be adequate to satisfy ongoing working capital needs
of the Company. The Company maintains a revolving credit facility of $500
million. As of March 31, 2006, the Company had $195 million of borrowings
outstanding under this facility and had issued approximately $137 million of
letters of credit, resulting in unused commitments of approximately $168
million. The Company also has $550 million of senior unsecured debt and equity
securities available for issuance under an effective shelf registration
statement. In addition, the Company has an arrangement enabling it to sell, on
a revolving basis, certain receivables to unrelated third party purchasers. The
agreement is a 364-day facility that is renewable at the option of the
purchasers. The Company may sell up to $70 million of its receivables to

22

these
purchasers in the future and therefore would have immediate access to cash
proceeds from these sales. The amount of the eligible receivables varies during
the year based on seasonality of the business and will at times limit the
amount available to the Company. During the three month period ended March 31,
2006, there were no receivables sold to third parties under this
agreement.

There have
been no material changes in the Companys financing agreements since December
31, 2005. As described in the Companys 2005 Annual Report, the Company is
party to a number of debt agreements that require it to maintain certain
financial and other covenants, including limitations on indebtedness and an
interest coverage ratio. In addition, under certain circumstances, the
agreements may limit the Companys ability to pay dividends and repurchase
shares of common stock. These limitations are not expected to be a factor in
the Companys dividend and share repurchase plans in the near future. Failure
by the Company to maintain these covenants could result in the acceleration of
the maturity of the debt. At March 31, 2006, the Company was in compliance with
the covenants related to these debt agreements and, based on its operating
outlook for the remainder of 2006, expects to be able to maintain compliance in
the future. The Company does not have any debt agreements that contain put
rights or provide for an acceleration of maturity as a result of a change in
credit rating.

The Company
maintains lease facilities with banks totaling $68 million which provide for
the acquisition and development of branch properties to be leased by the
Company. At March 31, 2006, there was approximately $68 million funded under
these facilities. Approximately $15 million of these leases have been included
on the balance sheet as assets with related debt as of March 31, 2006 and
December 31, 2005. The balance of the funded amount has been treated as
operating leases. Approximately $15 million of the available facility expires
in January 2008 and the remaining $53 million expires in September 2009. The
Company has guaranteed the residual value of the properties under the leases up
to 82 percent of the fair market value at the commencement of the lease. At
March 31, 2006, the Companys residual value guarantee related to the leased
assets totaled $56 million for which the Company has recorded the estimated
fair value of this guarantee (approximately $0.9 million) in the Consolidated
Statements of Financial Position.

The majority of the
Companys fleet and some equipment are leased through operating leases. The
lease terms are non-cancelable for the first twelve-month term, and then are
month-to-month, cancelable at the Companys option. There are residual value
guarantees (ranging from 70 percent to 87 percent depending on the agreement)
on these vehicles and equipment, which historically have not resulted in
significant net payments to the lessors. At March 31, 2006, there was
approximately $253 million of residual value relating to the Companys fleet
and equipment leases. The fair value guarantee of the assets under the leases
is expected to fully mitigate the Companys obligations under the agreements.
At March 31, 2006 the Company has recorded the estimated fair value of this
guarantee (approximately $0.6 million) in the Consolidated Statements of
Financial Position.

The Companys 2005 Annual
Report included disclosure of the Companys contractual obligations and
commitments as of December 31, 2005. The Company continues to make the
contractually required payments and therefore, the 2006 obligations and
commitments as listed in the December 31, 2005 Annual Report have been reduced
by the required payments. There were no significant additions to the Companys
obligations during the three months ended March 31, 2006.

Financial
Position

Receivables
increased from year-end levels, reflecting the acquisition of InStar and an
increase in American Home Shield customers paying on account. Inventories
increased from year-end levels, reflecting general business growth and
increased seasonal activity. Prepaid expenses and other assets increased from
year-end primarily reflecting preseason advertising costs at TruGreen ChemLawn
and Terminix as well as costs of annual repair and maintenance procedures that
are performed in the first quarter at TruGreen ChemLawn. These costs are
deferred and recognized over the production season and are not deferred beyond
the calendar year end. Deferred customer acquisition costs increased reflecting
the seasonality in the lawn care operations. In the winter and early spring,
this business sells a series of

23

lawn
applications to customers, which are rendered primarily in March through
October. These direct and incremental selling expenses which relate to
successful sales are deferred and recognized over the production season and are
not deferred beyond the calendar year-end. The Company capitalizes sales
commissions and other direct contract acquisition costs relating to termite
baiting and pest contracts, as well as home warranty agreements. These costs
vary with and are directly related to a new sale.

Property and
equipment increased from year-end levels primarily reflecting the InStar
acquisition. The Company does not have any material capital commitments at this
time.

The increase
in accounts payable from year-end levels reflects seasonality, growth at
several of the business units and the acquisition of InStar. Deferred revenue
increased from year-end levels, reflecting the significant amount of customer
prepayments recorded in the first quarter (pre-season) at TruGreen ChemLawn.
Payroll and related expenses have decreased from year end levels reflecting
incentive compensation payments related to 2005 performance that had been
accrued at year-end.

The Company
has minority investors in Terminix. This minority ownership reflects an
interest issued to the former owners of the Allied Bruce Terminix Companies in
connection with the acquisition of that entity. At any time, the former owners
may convert this equity security into eight million ServiceMaster common
shares. The ServiceMaster shares are included in the shares used for the
calculation of diluted earnings per share whenever their inclusion has a
dilutive impact. ServiceMaster has the ability to require conversion of the
security into ServiceMaster common shares, provided the closing share price of ServiceMasters
common stock has averaged at least $15 per share for 40 consecutive trading
days.

Total
shareholders equity was approximately $1.0 billion at March 31, 2006, and $1.1
billion at December 31, 2005. The decrease reflects operating profits in the
business offset by the provision for the expected loss on the disposition of
certain ARS/AMS properties held pending sale, cash dividend payments and share
repurchases.

BUSINESSES
HELD PENDING SALE AND DISCONTINUED OPERATIONS

The first
quarter 2006 loss from businesses held pending sale and discontinued operations
included a ($25) million after-tax impairment charge for expected losses on the
disposition of certain American Residential Services/American Mechanical
Services (ARS/AMS) properties held pending sale. Management currently expects
future gains on the disposition of other ARS/AMS properties, which will be
recognized in subsequent quarters when actually realized. Excluding the
aforementioned charge, the after-tax loss of ($1.5) million reflected a modest
improvement in operating results at ARS/AMS offset by the unfavorable
resolution of a claim related to a business sold in prior years.

The assets and liabilities
related to businesses held pending sale and discontinued operations have been
classified in separate captions on the Condensed Consolidated Statements of
Financial Position. Assets from businesses held pending sale and discontinued
operations have declined from year-end levels resulting from collections on
receivables at AMS and the provision for expected losses on the disposition of
certain ARS/AMS properties. The decrease in liabilities from businesses held
pending sale and discontinued operations represents decreases in payables and
other current liabilities at the ARS and AMS businesses. The remaining
liabilities primarily represent payables and other current liabilities at the
businesses held pending sale and obligations related to long-term
self-insurance claims.

24

Forward-Looking
Statements

The Companys Form 10-Q filing
contains or incorporates by reference statements concerning futureresults and other matters
that may be deemed to be forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. The Company intends that
these forward-looking statements, which look forward in time and include
everything other than historical information, be subject to the safe harbors
created by such legislation. The Company notes that these forward-looking
statements involve risks and uncertainties that could affect its results of
operations, financial condition or cash flows. Factors that could cause
actual results to differ materially from those expressed or implied in a
forward-looking statement include the following (among others): weather
conditions that affect the demand for the Companys services; changes in the
source and intensity of competition in the markets served by the Company; labor
shortages or increases in wage rates; unexpected increases in operating costs,
such as higher insurance premiums, self insurance and health care claim costs;
higher fuel prices; changes in the types or mix of the Companys service
offerings or products; increased governmental regulation, including
telemarketing and environmental restrictions; general economic conditions in
the United States, especially as they may affect home sales or consumer
spending levels; time, expenses and cash flows associated with integrating,
selling, or winding down businesses; and other factors described from time to
time in documents filed by the Company with the Securities and Exchange
Commission.

25

QUANTITATIVE AND
QUALITATIVE DISCLOSURES
ABOUT MARKET RISK

The economy and its impact
on discretionary consumer spending, labor wages, fuel prices, self-insurance
and insurance costs and medical inflation rates could be significant to future
operating earnings.

The Company does not hold or
issue financial instruments for trading or speculative purposes. The Company
has entered into specific financial arrangements, primarily fuel hedges, in the
normal course of business to manage certain market risks, with a policy of
matching positions and limiting the terms of contracts to relatively short
durations. The effect of derivative financial instrument transactions is not
material to the Companys financial statements.

In December 2003 and January
2004, the Company entered into interest rate swap agreements with a total
notional amount of $165 million. Under the terms of these agreements, the
Company pays a floating rate of interest (based on a specified spread over
six-month LIBOR) on the notional amount and the Company receives a fixed rate
of interest at 7.88 percent on the notional amount. The impact of these
swap transactions was to convert $165 million of the Companys debt from a fixed
rate of 7.88 percent to a variable rate based on LIBOR (8.7 percent average
rate during the three months ended March 31, 2006).

The Company generally
maintains the majority of its debt at fixed rates. After the effect of the
interest rate swap agreements, approximately 55 percent of total debt at March
31, 2006 was at a fixed rate. With respect to other obligations, the payments
on the approximately $68 million of funding outstanding under the Companys
real estate operating lease facilities as well as its fleet and equipment
operating leases (approximately $253 million in residual value) are tied to
floating interest rates. The Companys exposure to interest expense based on
floating rates is partially offset by floating rate investment income earned on
cash and marketable securities. The Company believes its overall exposure to
interest rate fluctuations is not material to its overall results of
operations.

The Company has several debt
and lease agreements where the interest rate or rent payable under the agreements
automatically adjusts based on changes in the Companys credit ratings. While
the Company is not currently expecting a change in its credit ratings, based on
amounts outstanding at March 31, 2006, a one rating category improvement in the
Companys credit ratings would reduce pre-tax annual expense by approximately
$0.6 million. A one rating category reduction in the Companys credit ratings
would increase pre-tax expense on an annualized basis by approximately $1.1
million.

The following table summarizes
information about the Companys fixed rate debt as of December 31, 2005,
including the principal cash payments and related weighted-average interest
rates by expected maturity dates. The fair-value of the Companys fixed rate
debt was approximately $491 million at December 31, 2005.


Expected
Maturity Date(In
  millions)
  
  2006
  
  2007
  
  2008
  
  2009
  
  2010
  
  There-
  after
  
  TotalFixed rate
  debt
  
  $
  19
  
  $
  61
  
  $
  12
  
  $
  25
  
  $
  8
  
  $
  359
  
  $
  484Avg. rate
  
  
  5.7
  %
  
  7.1
  %
  
  7.1
  %
  
  7.8
  %
  
  7.9
  %
  
  7.5
  %
  
  7.4
  %As previously discussed, the
Company has entered into interest rate swap agreements, the impact of which was
to convert $165 million of the Companys 2009 maturity debt from a fixed rate
of 7.88 percent to a variable rate based on LIBOR.

26

CONTROLS AND
PROCEDURES

The Companys
Chairman and Chief Executive Officer, Jonathan P. Ward, and the Companys
President and Chief Financial Officer, Ernest J. Mrozek, have evaluated the
Companys disclosure controls and procedures as of the end of the period
covered by this report.

The Companys
disclosure controls and procedures include a roll-up of financial and
non-financial reporting that is consolidated in the principal executive office
of the Company in Downers Grove, Illinois. The reporting process is designed to
ensure that information required to be disclosed by the Company in the reports
that it files with or submits to the Securities and Exchange Commission is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commissions rules and forms. Messrs. Ward and
Mrozek have concluded that both the design and operation of the Companys
disclosure controls and procedures are effective.

There were no
changes in the Companys internal control over financial reporting that
occurred during the Companys most recent fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Companys internal
control over financial reporting.

27

PART II. OTHER INFORMATION

Item 1A: Risk Factors

There have been no material
changes from the risk factors previously disclosed in the Companys 2005 Annual
Report.

Item 2: Unregistered Sales of Equity Securities and Use
of Proceeds

Share Repurchases:

In February 2006, the Board
of Directors authorized $250 million for share repurchases. This authorization
replaces the unused portion ($30 million at December 31, 2005) from the
previous authorization granted in July 2000. The following table summarizes the
Companys common stock share repurchases for the three months ended March 31,
2006 under its share repurchase authorization. Decisions relating to any future
share repurchases will depend on various factors such as the Companys
commitment to maintain investment grade credit ratings and other strategic
investment opportunities.

Total Number
  of Shares
  Purchased
  
  Average Price
  Paid per
  Share
  
  Total
  Number
  of Shares
  Purchased as
  Part of Publicly
  Announced
  Plan
  
  Approximate
  Dollar Value
  of Shares that
  May Yet be
  Purchased
  Under the
  PlanJanuary 1,
  2006 throughJanuary 31,
  2006
  
  
  
  
  $
  
  
  
  
  
  $
  250,000,000February 1,
  2006 throughFebruary 28,
  2006
  
  
  1,320,100
  
  $
  12.43
  
  
  1,320,100
  
  $
  234,000,000March 1,
  2006 throughMarch 31,
  2006
  
  
  2,150,083
  
  $
  12.90
  
  
  2,150,083
  
  $
  206,000,000Total
  
  
  3,470,183
  
  $
  12.72
  
  
  3,470,183Item 6: Exhibits

Exhibit
  No.
  
  Description
  of Exhibit31.1
  
  Certification
  of Chief Executive Officer Pursuant to Rule 13a  14(a) or 15d  14(a), as
  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
  
  Certification
  of Chief Financial Officer Pursuant to Rule 13a  14(a) or 15d  14(a), as adopted
  pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
  
  Certification
  of Chief Executive Officer Pursuant to Section 1350 of Chapter 63 of Title 18
  of the United States Code, as adopted pursuant to Section 906 of the
  Sarbanes-Oxley Act of 200232.2
  
  Certification
  of Chief Financial Officer Pursuant to Section 1350 of Chapter 63 of Title 18
  of the United States Code, as adopted pursuant to Section 906 of the
  Sarbanes-Oxley Act of 200228

SIGNATURE

Pursuant to the requirements
of the Securities Exchange Act of 1934, the Registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: May 9, 2006

THE SERVICEMASTER COMPANY(Registrant)By:
  /s/ Ernest J. MrozekErnest J. MrozekPresident and Chief
  Financial Officer29