Combine sugar and watermelon lemonade in saucepan. Bring to a boil 8 to 10 min., or until reduced by half. Stir until sugar dissolves. Cool completely.
Puree watermelon in blender until slushy. Add cooled syrup, lime zest and vanilla. Pulse to combine. Pour into 9-in. (23 cm) square metal pan or similar-size freezable container. Cover and freeze 4 to 6 hr., or until firm.
Remove from freezer and let stand 5 min. to slightly soften. Break up into large chunks and transfer into food processor; pulse until slushy. Use a spoon or fork to stir in chocolate chips (do not pulse in). Transfer mixture back into freezing container. Cover and freeze 2 to 4 hr., or until firm. Scoop into ice cream cones or dessert bowls to serve
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