If the user clicked Cancel on the dialog box then the document would open in a read-only version. After much research and few leads we found a post that said to avoid the login prompt you need to turn off Client Integration. This can be found in the Central Administation Panel under two locations under Application Management, User Permissions for Web Application and Authentication Providers. You should set this setting in the Authentication Providers section. This way you can set it for each type of authentication zone, both anonymous and authenticated.
In order to use SharePoint Designer with the site you will need the Client Integration turned on for the authenticated user. Disable client integration for anonymous users. This will remove the prompt in some Office/browser combinations.
To remove it for the rest, you will need to remove the "Options" verb from the httpHandlers section of the web.config for the anonymous site collections.
This link is the original site where we found this information.
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