Are you sure nothing happened? file2 was created, right? I'll bet if you look closely, you'll find the first - on each line was changed to a space in file2. You need to put a 'g' at the end to tell sed to do the replace everywhere, instead of just the first match it finds. So:
sed -e 's/-/ /g' file > file2
should do what you want (the extra backslash you added isn't necessary, but won't hurt either).